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March 24, 2009
| We Been Tranched | Economy |
Collateralized mortgage obligations (CMOs) work something like this. A large number of mortgages are put into a trust, and the mortgages are then sliced into horizontal layers, or tranches. In a very simple example there might be three tranches. The top tranche might contain 70% of the mortgages by dollar amount, the middle tranche 20%, the bottom tranche 10%. The trick is that as payments come in on the mortgages, the top tranche gets first claim on all the incoming cash flow. People figured there was no way 30% of the mortgages would default so the top tier was definitely going to get paid, and so it got a triple-A rating, basically as good as money. The middle tranche got first dibs on the remaining cash flow, so it was golden, too, unless more than 10% of the mortgages defaulted. That made it more risky than the top, so it paid a higher rate of return, but it still seemed pretty solid. The bottom tranche was the last to get paid, so it was the riskiest, one of those toxic assets we hear so much about.
So I watch what's happening with the "bailout" plans, and it strikes me that it's tranches all over again. The top tranche consists of the likes of AIG, Citigroup, Bank of America, and JP Morgan Chase. They get paid first. If there's money left over, the middle tranche gets paid. That's GM and Chrysler and a bunch of smaller banks. The bottom tranche? That's us.
Actually, it's worse than that. Not only do we in the bottom tranche get paid last, we're the ones, collectively, who are doing the paying. The top tranche, meanwhile, consists of the firms most responsible for the mess we're in. They made the biggest, riskiest bets and raked in the largest returns until the bubble popped, and now they're first in line for payouts from us taxpayers. They, and their problems, are all we ever hear about.
What a hustle.
Posted by Jonathan at March 24, 2009 08:42 PM
Comments
Thank God you're back. I won't ask why you were offline so long. Best wishes, Jon, to you and your family. Thanks for all your hard work in the past and big smile for today!
Wolf
Posted by: Wolf DeVoon at March 29, 2009 04:30 AM