What! What! What! can be done to bring real accountability to them and stop this expectation that we have to pay for their party when we’re not even invited?

Asia Real, Ventura California

Exaclty how do mortgage backed secrutities work and how are they any different from CDO’s?From what i can piece together is that MBS’s are basically the right to the cash flow from a mortgage??So mortgage lenders would lend to person A. They would then sell that mortgage to some 3rd party. The 3rd part would sell the right to the mortage payments to so different investors after getting it rated by an agency,correct?

In the extract above it refers to “junk securities” and “shell companies’.What are those exactly?Sorry for so many questions =D.

Thanx for your time,
james

It would take too much space to explain it this sufficient detail, so I will just offer a few basics. If you have further questions, I can try to address them. I have written a bit more about this here: http://outlookindia.com/full.asp?fodname=20080926&fname=ali&sid=1
That piece might give you an idea of the casino capitalism that was rampant during the deregulated phase, and explain a few basic things that’ll allow the following to make more sense.

There were several regulatory “lapses” during the period that led up to the crisis. Institutions such as Fannie Mae and Freddie Mac had been set up to buy mortgages from lending institution, thus freeing up more capital for more lending to more homeowners. In an increasingly deregulated environment, they were allowed to cut, mix, and repackage these mortgages as abstract securities, and to resell them, thus creating a largely unregulated market for fancy and risky derivatives (see below for a better explanation of this process). Lenders of subprime loans were pretty much unregulated too, since many of them weren’t even banks, but merely mortgage companies that made the loans, and then sold the mortgages to players on Wall Street. And players there were a-plenty, including a whole host of new ones called hedge funds and private equity firms, who were left alone to do as they pleased. Also, the Clinton administration (in 1999) repealed the Glass-Steagall Act that separated comercial banks and investment banks, allowing bankers to underwrite securities and sell them to investors.

But there were two MAJOR deregulatory forces that had more to do with this crisis than any other. One was the fact that investment banks were allowed to leverage their capital heavily. So for instance, for every $1 it held in capital, Morgan Stanley had $30 in debt. This allowed the financial institutions to bet heavily with borrowed money. Which was great as long as the going was good, but it magnified the losses massively when the downturn came along.

The second problem was a strange one. The government chose to look the other way on several issues of conflict of interest. Remember Enron? It had hired Arthur Anderson to audit its books, even while it retained the same company for huge consulting projects. The Sarbanes-Oxley Act fixed that but only after a major debacle, which claimed several prominent organizations. In the case of the current crisis, the securites that were created out of the mortgages (see below for an explanation I have cut-and-pasted from my other piece) became desirable only because credit rating agencies like Moody’s and Standard & Poor’s gave them AAA ratings. Why did they do that? Well, financial institutions that want to sell their securites hire the rating agencies for a large fee to help them convert their mortgages into securities that can be sold in the market. Shouldn’t the rating agency be an independent – maybe a government-run – organization that doesn’t have a dog in the fight?

Should the Congress have created a regulatory body when the boom was underway? Perhaps. But there was enough leeway even within the system for regulators to act in a way that might have prevented the worst of these excesses. But the administration wasn’t exactly a public-minded one, was it?

Hope this helps,
Ali

An explanation about the securities racket:
Securitization is a fancy word for the creation of fictitious products called “securities” (which are themselves based on actual assets that are expected to generate income). This is how the game was played: the get-rich-quick Wall Street crowd peddled these subprime loans that they knew very well were predatory, created a bunch of abstract securities by using the mortgage as collateral, packaged them with fancy labels called MBSs-CDOs-CMOs, persuaded credit rating agencies to attach AAA labels to some of the securities, sold these to investors, exploited accounting loopholes to create shell companies called Special Purpose Vehicles (SPVs) in the Cayman Islands and other tax havens, and transferred the junk securities to the balance sheet of the SPVs. So by the time they were done, they had taken crappy mortgages and converted them partly into AAA securities, partly into lower rated ones, and partly into trash that was no longer on their own books (these are the various “tranches” we keep hearing about).