Monday, April 13, 2009

How Money is Derived from Derivatives Called "Mortgage Backeds"

The Chart above shows how Mortgage Backed Securities "MBS" come into existence.
(Chart author/designer unknown)

Terms used - (Green = $$$):
a. Originator=Lender
b. Arranger=the "putter together" of the mortgages
c. Trust=Holder of the MBS money
d. AAA-Purple=the MBS itself
e. Investors= buyers of the
f. Manager= Loan servicer
g. Houses= collateral for the MBS)

Hopefully, you have some idea of what a "Derivative" is and that a "Credit Default Swap" is really a kind of "Derivative". Further, that "Mortgage Backed Securities" are just sophisticated I.O.Us, where the "Arrangers" of the MBS say to the investors (mutual funds, banks, of just retail investors) that the "Arranger" wants to borrow money and will pledge mortgages as collateral. But, rather than pledging a mortgage at a time, the creators group thousands together and sell them as one big I.O.U. The pieces may be $1,000, $10,000 or $10,ooo,ooo (Think of a large pie sliced into some large and some tiny pieces).

Here is a restatement of the past posts about these topics:
1. Thousands of mortgages are put together.
2. The creator of this pool of mortgages offers to sell the right to receive income from the pool at a pre-determined rate of interest.
3. An investor can buy up to 100% of the pool.
4. The investor will be paid interest on the amount of the pool he/she buys
5. No one actually is buying any of the mortgages that make up the Pool, just the right to receive income from the Pool, based on the average of the interest rate for all of the mortgages in the Pool, after all costs, losses, and profits are deducted
6. The creator of the Pool/Mortgage Backed Security will sell the investor the I.O.U. based not on the actual cash received from mortgage payments, but merely on his/her/its promise to pay. (It's not like all of the money gets collected and someone divides it up into a thousand or two thousand little piles).
7. In case all else fails, IN THEORY, there is collateral for the Creator of the Pool, not the investors. The collateral is the homes that are mortgaged. The Creator of the Pool can liquidate homes that are the collateral for the mortgages that default, and use that money to pay the investors each month.
8. The Creator/Seller of the MBS, is selling the right to receive an I.O.U. which pays interest to the "Buyer" of the I.O.U. (Investor) based on the hopeful profit from the mortgage payments.


9. The right of the Investor to receive the money for the I.O.U. is DERIVED from the Mortgage Backed Security, which has the right to collect money DERIVED from the underlying Mortgages, which is DERIVED from the Mortgagor's (the original borrower/homeowner) I.O.U. to the Bank/Lender. All of this is based on the sale value of the real estate that has been mortgaged by the Homeowner.

If you are still confused, refer to the chart at the top of the post. If you are still confused, join the ranks of MOST lawyers, accountants, stock brokers, and most of Congress.

The next post will deal with the Administration's first step to getting some of the BAILOUT mortgage money to regular homeowner-type people.
Author's Copyright (Text Only) by Richard I. Isacoff, Esq, April, 2009

1 comment:

Anonymous said...

Great breakdown.