Mortgage Crisis Redux

Okay, I don't understand a lot but here's how I see this whole financial crisis unfolded:

1.) Over the past few years one of the great financial innovations created was Mortgage Backed Securities (MBS.) What you do is the following:

A small bank or someone gives someone a mortgage. They lend them money for a house and then they get periodic payments to pay back the principal (i.e. the original money lent) plus interest. So for the next e.g. 30 years the bank gets $1,500 or whatever every month.

What big banks did was buy these mortgages from smaller banks. You buy them at a certain price and now you get the monthly payments. You do it with a ton so you have a continuous stream of payments. Every day money comes in (b/c obviously some people pay on the first of the months, some on the third, some on the 15th, &c.)

The the big bank takes, let's say, 1,000 of these mortgages and "bundles" them together. What does that mean? It just means that those are "thrown into one big pot." The money that comes in every day from those 1,000 mortgages is all thrown into one big pot.

The big bank paid a certain amount for those 1,000 mortgages. So obviously they could just resell those 1,000 mortgages to someone else. But, unless you're rich, you don't have enough money to buy 1,000 mortgages.

So what the big bank does is it just splits this one big pot of money with a stream of money coming in all the time into e.g. 100 million little pieces. Each one of these pieces is now easily available for $100 (or around there.) And then they go ahead and sell that to anyone who wants one of those little pots. And let's also say that they just keep the money that comes in a safe for a little bit and pay you every month or every six months. That's what a Mortgage Backed Security is.

Of course some people are going to default on their mortgages but that's not that big of a deal b/c a) it's just a handful of those underlying 1,000 mortgages and b) if someone defaults you still get a part of the house that they put up as collateral. And of course it's much better for me as an individual to own one of those little pots of money instead of one mortgage where, if the homebuyer defaults, I'm screwed. AND I get maybe a 5% return whereas on some Treasury bond I get close to nothing. And the rating agencies have said these things are secure so I'm kinda thinking they are.

2.) Of course, back when, all these people with no income and no assets got a mortgage. Makes sense if I'm the small bank. I do the mortgage, sell it to the big bank. If they are too dumb to buy it, not my problem. The big banks... well, they just bundle it all together, slice it up, hope all goes well and sell it to someone else. Not their problem anymore.

3.) Now all those NINA (no income, no assets) people start to default on their mortgages. Surprise!!! The big bank gets the house and tries to sell it. But people are defaulting on mortgages left and right. Everyone who wanted a house got a house and everyone who can't pay for it is defaulting. No one wants to take the house off the big bank's hands.

4.) Of course for the owner of the small pots of money that sucks. More people than I thought are defaulting on the mortgages (so I don't get as much money every month) and the collateral they leave behind is worthless, too.

5.) Okay fine, Ima try to sell my MBSs. But EVERYONE owns these securities. They become worth ever less.

6.) If you're a big bank that owns a ton of these MBSs the value of all your asset drops. But the government requires you to have a certain amount of assets in the basement just in case someone comes and wants to withdraw all their money. But now you don't have that anymore. So either you have to sell off business units or... or who knows.

7.) Except for no one wants to buy your stuff now b/c everyone else owns the mortgage backed securities and is strapped for cash.

8.) Okay, so the first thing I, a big bank, stop doing is lending out money to businesses. I have no idea who else owns how much of this stuff and isn't going to pay me back.

9.) And that's what Ben Bernanke means when he says that the arteries of the economy are frozen.

So fast-forward to a year later. We're possibly slowly recovering. Everyone has been slapped on the fingers, and a lot of big banks are still hurting (not to mention the rest of the us.) How do I, as a big bank, make up for all the losses, all the jobs lost, all the bonuses forgone? Oh, easy!

The NYT reports:Wall Street Pursues Profit in Bundles of Life Insurance

Ummmm.... seems like a great idea? You bundle all these payments, slice them up, sell them to a ton of peop.... errrrr....