I have had lots of discussions among my friends regarding the mortgage meltdown. Wired has this article which hits many of the items my friends and I have discussed.
The concept is that a Mortgage servicer (think your local bank) originates your mortgage and at some time in the year, sells your mortgage to a mortgage owner (think Fannie May). The mortgage owner, packages a number of mortgages in creative ways in order to create a Collateralized Debt Obligation (CDO). This CDO is treated like a bond, it has a face value and is placed on the market for investors to buy. The price paid for it is discounted in order to quantify risk.
The the problem originates when the market is unable to accurately gauge the risk of the CDO. When the market cannot gauge the risk, the market cannot set an accurate price for the CDO and the market collapses. This is what happened in late September.
The point that I like to make is that, in the information age, something like this should never happen. You don't need elegant or simple models to predict results. In the age where my phone company can tell me, to the minute, each call I make and to whom, the creators of each CDO ought to have sold the underlying data to each purchaser. Armed with the knowledge of who and what is being valued in an individual CDO, the market could judge the underlying risk of each CDO. Banks might have needed the TARP funds as a bridge measure, but the real way to solve this credit crisis is to expose the data underlying the so-called toxic assets and let the market begin to price them.
The concept is that a Mortgage servicer (think your local bank) originates your mortgage and at some time in the year, sells your mortgage to a mortgage owner (think Fannie May). The mortgage owner, packages a number of mortgages in creative ways in order to create a Collateralized Debt Obligation (CDO). This CDO is treated like a bond, it has a face value and is placed on the market for investors to buy. The price paid for it is discounted in order to quantify risk.
The the problem originates when the market is unable to accurately gauge the risk of the CDO. When the market cannot gauge the risk, the market cannot set an accurate price for the CDO and the market collapses. This is what happened in late September.
The point that I like to make is that, in the information age, something like this should never happen. You don't need elegant or simple models to predict results. In the age where my phone company can tell me, to the minute, each call I make and to whom, the creators of each CDO ought to have sold the underlying data to each purchaser. Armed with the knowledge of who and what is being valued in an individual CDO, the market could judge the underlying risk of each CDO. Banks might have needed the TARP funds as a bridge measure, but the real way to solve this credit crisis is to expose the data underlying the so-called toxic assets and let the market begin to price them.
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