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> When you have over 50% delinquencies, it is a bad thing. They didn't. The banks levered up so much that 7% of delinquencies was enough to crash the global e

> When you have over 50% delinquencies, it is a bad thing. They didn't. The banks levered up so much that 7% of delinquencies was enough to crash the global economy.

JumpCrisscross 8y ago
> 7% of delinquencies was enough to crash the global economy The delinquencies ended up being less of a problem than the uncertainty around them. 7% delinquencies didn't kill anyone. Investors' fears that 7 would become 20 did.
- deleted 8y ago
  [deleted]
cm2187 8y ago
No, on subprime portfolios, the delinquencies were as high as 50% sometimes worse.
btilly 8y ago
Can you provide a source? https://www.chicagofed.org/~/media/publications/profitwise-news-and-views/2010/pnv-aug2010-reed-final-web-pdf.pdf https://www.chicagofed.org/~/media/publications/profitwise-n... quotes average default rates in the 30+% range on subprime mortgages.
- gammateam 8y ago
  yes, it looks like you are correct. The Collateralized Debt Objects reduced this risk down by being bundled with better credit worthy debt servicing.
  - btilly 8y ago
    No, that is not how CDOs work. The way that securitization works is that you take many thin streams of cash from individual loans, and bundle them into a giant river of money. That river will dry up at some point, and what point depends on how much defaulting there is. You then take horizontal chunks out of that river and sell them off. The first few slices are low risk - they will pay off even if lots of people default. The last one is very high risk indeed and are only worth pennies on the dollar, if that. The principle is that it is safe not because it is bundled with better debt, but because those bonds still pay even if lots of people default. They may pay late, but they should pay. However the models quantifying the risk assumed that there was a lot less correlation in defaults than there actually was. So when the housing market moved against the loans at the same time as people lost jobs in the financial crisis, investments that were supposed to be safe suddenly weren't. I could believe 7% as the losses in bonds that originated as AAA bonds. But not as the losses in AAA bonds.
    - cm2187 8y ago
      That’s right, but perhaps I can give a stab at a more technical explanation. An RMBS is a portfolio of mortgages financed by multiple bonds, with an order of subordination between them. When a loss occurs on a mortgage, it is allocated to the most junior bond first, until it is fully written down, then the next junior bond, etc. So if you own the most senior bond (often rated AAA), you are really exposed to high default rates and high correlation. Ie if the portfolio of mortgages is diversified (low correlation) some mortages will default but not all at the same time, and there will always be enough mortgages that do not default to avoid a loss on the most senior bonds. The big fuck up in the financial crisis is that the correlation was misestimated. There had never been a large, US wide, real estate crisis since 1929 and therefore everyone assumed a US wide portfolio was well diversified. That turned out to be wrong in 2006-2007, and delinquencies (ie balances of loans not paying interest or principal) shot up. This led to losses (not 100% of a defaulted loan, the house still had some residual value) that ultimately hit the AAA bonds. A CDO is the same structure but using bonds in the portfolio instead of residential mortgages. But when people refer to large losses on CDOs in the financial crisis they usually refer to CDO of ABS, which basically uses junior RMBS bonds in the portfolio, so effectively you leverage the mortgages twice, first through an RMBS, and then another time through a CDO. In those you are even more exposed to correlation. The portfolio is made up of junior RMBS bonds from multiple RMBS transactions originated by multiple subprime lenders across the country, so these structures were playing on not all of these RMBS going bad simultaneously, which is exactly what happened. So the TL DR is that these portfolio of subprime mortgages and RMBS bonds were of a similar credit quality, but correlation is what got really badly mispriced, they were assumed to be diversified but what we got is a large US wide real estate crisis that hit everybody,

> When you have over 50% delinquencies, it is a bad thing. They didn't. The banks levered up so much that 7% of delinquencies was enough to crash the global economy.

JumpCrisscross 8y ago

> 7% of delinquencies was enough to crash the global economy The delinquencies ended up being less of a problem than the uncertainty around them. 7% delinquencies didn't kill anyone. Investors' fears that 7 would become 20 did.

deleted 8y ago
[deleted]

cm2187 8y ago

No, on subprime portfolios, the delinquencies were as high as 50% sometimes worse.

btilly 8y ago

Can you provide a source? https://www.chicagofed.org/~/media/publications/profitwise-news-and-views/2010/pnv-aug2010-reed-final-web-pdf.pdf https://www.chicagofed.org/~/media/publications/profitwise-n... quotes average default rates in the 30+% range on subprime mortgages.

gammateam 8y ago
yes, it looks like you are correct. The Collateralized Debt Objects reduced this risk down by being bundled with better credit worthy debt servicing.
- btilly 8y ago
  No, that is not how CDOs work. The way that securitization works is that you take many thin streams of cash from individual loans, and bundle them into a giant river of money. That river will dry up at some point, and what point depends on how much defaulting there is. You then take horizontal chunks out of that river and sell them off. The first few slices are low risk - they will pay off even if lots of people default. The last one is very high risk indeed and are only worth pennies on the dollar, if that. The principle is that it is safe not because it is bundled with better debt, but because those bonds still pay even if lots of people default. They may pay late, but they should pay. However the models quantifying the risk assumed that there was a lot less correlation in defaults than there actually was. So when the housing market moved against the loans at the same time as people lost jobs in the financial crisis, investments that were supposed to be safe suddenly weren't. I could believe 7% as the losses in bonds that originated as AAA bonds. But not as the losses in AAA bonds.
  - cm2187 8y ago
    That’s right, but perhaps I can give a stab at a more technical explanation. An RMBS is a portfolio of mortgages financed by multiple bonds, with an order of subordination between them. When a loss occurs on a mortgage, it is allocated to the most junior bond first, until it is fully written down, then the next junior bond, etc. So if you own the most senior bond (often rated AAA), you are really exposed to high default rates and high correlation. Ie if the portfolio of mortgages is diversified (low correlation) some mortages will default but not all at the same time, and there will always be enough mortgages that do not default to avoid a loss on the most senior bonds. The big fuck up in the financial crisis is that the correlation was misestimated. There had never been a large, US wide, real estate crisis since 1929 and therefore everyone assumed a US wide portfolio was well diversified. That turned out to be wrong in 2006-2007, and delinquencies (ie balances of loans not paying interest or principal) shot up. This led to losses (not 100% of a defaulted loan, the house still had some residual value) that ultimately hit the AAA bonds. A CDO is the same structure but using bonds in the portfolio instead of residential mortgages. But when people refer to large losses on CDOs in the financial crisis they usually refer to CDO of ABS, which basically uses junior RMBS bonds in the portfolio, so effectively you leverage the mortgages twice, first through an RMBS, and then another time through a CDO. In those you are even more exposed to correlation. The portfolio is made up of junior RMBS bonds from multiple RMBS transactions originated by multiple subprime lenders across the country, so these structures were playing on not all of these RMBS going bad simultaneously, which is exactly what happened. So the TL DR is that these portfolio of subprime mortgages and RMBS bonds were of a similar credit quality, but correlation is what got really badly mispriced, they were assumed to be diversified but what we got is a large US wide real estate crisis that hit everybody,