If you care to go back to some postings from 2008 and 2009 (specifically, Sept. 14, 2008), you will see a (sort of) primer on the creation of Mortgage-Backed Securities (MBS). In summary, an issuer of an MBS either creates a "Pass Through", which is a passive trust or a more complex structure such as a "Collateralized Mortgage Obligation" or CMO. Growing out of the CMO, the CDO or Collateralized Debt Obligation has become the structure of choice for the Street today. Many, if not most, CDO's contain some sort of credit enhancement like a Credit Default Swap or CDS. If this sounds familiar, it should. CDO's utilizing a CDS structure were the bonds that sank the ship in 2008 - think A.I.G. and lots of bail-out money.
A CDO is simply an arbitrage between the market for "collateral" - Pass Through MBS issued by Ginnie Mae, Fanny Mae, Freddy Mac or a Mortgage Company originating un-securitized "Whole Loans", many of which are not the best credits and are known as sub-prime loans. To get a deal done requires that an "issuer" be present. Typically the issuer is a Special Purpose Entity or SPE owned by an eleemosynary organization - usually a shell created by the bank behind the deal. In addition to an issuer, a deal must be structured so that the cash flow is different from the underlying collateral, e.g., differing average life, maturity & etc. The deal must also contain an "equity" component or tranche. Now, in the good old days when I was in the Street, you could NOT get a deal done unless you first had the equity placed with an investor. Needless to say, institutions willing to take the kind of risk that went along with equity tranche ownership, were few and far between. Beginning in about 2005 or 2006, there was so much demand for mortgage credit and there was so much money in the arbitrage, that the Street began to hold the equity tranches themselves. You know what that ownership led to. Now, it is happening again. The following was taken from the NY Times of Jan. 24: By NY Times EDITORIAL BOARD JAN. 24, 2015 There have been powerful reminders in recent days that the financial system needs more regulatory vigilance, not less. But they come just as Republicans are setting their agenda in Congress, complete with vows to weaken the Dodd-Frank reform law. On Thursday, The Times’s Nathaniel Popper reported that Goldman Sachs is using the bank’s money to make big bets in real estate. That appears to be a violation of the spirit, if not the letter, of Dodd-Frank, which aims to avoid bailouts by reducing concentrated risks at banks. Similarly, the still-unfolding fallout from the unexpected surge this month in the value of the Swiss franc — including huge losses at brokerages and hedge funds — serves as a reminder that certain foreign-exchange derivatives were allowed to escape regulation under Dodd-Frank. The argument against such regulation, as put forth by Obama officials, was that foreign exchange trading is staid and stable, a view that never made sense and that has since been undermined, not only by the volatile Swiss franc episode, but by recent revelations of widespread manipulation of the foreign-exchange market by big banks. Unfortunately, those regulatory challenges are not the only ways in which Dodd-Frank’s promise has gone unmet. The law required regulators to write hundreds of rules and conduct dozens of studies before the law’s many reforms could be put into place. In the process, some regulators found room to indulge their pro-bank biases. Regulators were also subject to unrelenting pressure — by bank lobbyists; by Republicans, who have been hostile to the law from the start; and by several Democrats, who want credit for passing the law but also want to please their Wall Street contributors. |
The result has been delays, weak rules and political setbacks, including budget
constraints that impair regulatory enforcement of the law and, recently, the
outright repeal of a provision to curb excessive speculation by banks. In a
maneuver that hints at things to come, that repeal was achieved by attaching the
provision to a spending bill that President Obama and many congressional
Democrats said was more important than standing firm on the reform.
Going forward, even the Consumer Financial Protection Bureau, the biggest success of the Dodd-Frank law, is threatened by Republicans who want to change the agency’s financing and leadership structure to make it less independent. The question is whether President Obama and Democrats in Congress will repel the efforts of opponents to strip away reforms before they even have a chance to take root. |
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