Repackaged and Reinvented Debt ala the CDO!
The subprime crisis, essentially, an investment banking contraption. But what is it? It started with investment banks purchasing subprime mortgages, bundling and securitizing them. Then they were cut into tranches, sold, and repackaged several times (often into collateralized debt obligations). It was happening so fast the ratings companies couldn’t keep up with the number of times the debt was repackaged. Each time the debt was sliced and diced it became a new securities product with differently configured debt. As the quality of the collateral changed, the CDO’s maintained the investment grade ratings. Demand was so high by the pension funds, hedge funds, commercial banks, and institutional investors bought the securities beating the market interest rates. Because the market for these instruments was seemed so strong, investment banks and institutional investors borrowed more and more to create additional investment products, including shaky subprime assets. Once the homeowners started to default, investors controlling the assets, not the original lending institutions, went straight to foreclosure to cut their losses. The investors began to unwind their CDO positions. However, the market was already limited for these securities as banks and many institutions were faced with margin and collateral calls from nervous banks. To raise cash, large investors were forced to sell other assets, such as stocks and bonds. Thus began the current credit crisis.
