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Today: 20.01.2018 - 03:25:46
   Canada Mortgage Hub Discussion Board -> Mortgage Rates Canada -> Why were Bankers and stock brokers allowed to create all these new sub-standard securities?
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octa

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Why were Bankers and stock brokers allowed to create all these new sub-standard securities?
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nonconcludency11422

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Because they wanted to sustain the housing bubble, which in turn boosted consumption. home equity credit line, for some families that was an extra 3000/month. Now with house prices dropping thats money that will be missed.
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projectseven

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Too short answer is this--please read the long article by my source because this is the first time I've heard it so clearly put AND it should serve as a lesson to everyone:mortgages were packaged into something called tranches--and there were three tiers of them--one was investment grade (prime) and two were more high-risk with correspondingly higher yields (the usual LAW of economics which means higher risk requires higher reward). The most risky level were beloved of hedge funds which don't have to have substantial capital reserves. They overtextended themselves, but becasue so many existed, they were a major part of this market. These deals were done on the OTC with little public view and the house of cards collapsed. Because banks and such had invested in these highly risky securities, though NOT directly, they had a problem. It hit the US very hard (it was our mortgages). It hit Canada. It took down Northern Rock. It's been felt outside of these markets as well."Unlike publicly traded securities and futures contracts, these collateralized debt obligations and credit derivatives are not traded on exchanges. Instead they trade in over-the-counter (OTC) markets. Exchanges act as go-betweens in every sale and trades are public; in OTC markets, trading is bilateral between customers and dealers, and prices and volumes of trades are not disclosed. The price discovery process is not transparent, and there is no surveillance of the market to identify where there are large or vulnerable positions. Moreover, unlike exchanges, these OTC markets have no designated or otherwise institutionalized market makers or dealers to ensure liquidity. As a result, when major events send prices reeling, dealers stop acting as market makers and trading can cease.When the crunch hit this past August, the markets for subprime mortgage-backed securities became illiquid at the very time that highly leveraged investors such as hedge funds needed to adjust positions or trade out of losing positions (see chart). This left hedge funds locked into damaging positions at the same time they faced margin calls for collateral from their prime brokers. (Hedge funds borrow against the value of their assets, and when those values fall, hedge funds need to come up with fresh capital or sell off assets to repay the loan.) The situation was exacerbated because, without trading, there were no market prices to serve as benchmarks and no way to determine the value of the various risk tranches.As a result, hedge funds stopped trading, and the collateralized debt obligation market and related credit derivatives markets essentially ceased to exist. Issuers of collateralized debt obligations could not sell their inventory and stopped arranging new issues.With no buyers in the secondary market, the subprime mortgage originators could not sell the loans they had made. This put enormous pressure on the many originators—a large number of which were thinly capitalized, unregulated finance companies. In turn, the bankers to these originators withdrew their funding, and the originators were unable to carry the inventory of mortgages they had made. They immediately stopped making new loans, at least new subprime loans, and some filed for bankruptcy protection. In turn, prospective home buyers and refinancing homeowners could not obtain nonconforming mortgages, which prevented those with payment problems from refinancing to avoid default. Demand in the housing industry shriveled.At the same time that hedge funds and other investors stopped buying high-risk tranches of subprime risk, buyers of commercial paper—corporate IOUs that are normally at the top of the creditworthiness pecking order—–ceased purchasing asset-backed commercial paper after it came to light that the underlying assets were the investment-grade-rated tranches of subprime mortgages. High credit ratings were once enough to satisfy investors' concerns about credit risk, but the collapse in prices of equity and mezzanine tranches led investors to reassess the investment-grade risk segments. The major banks and broker-dealers that had made guaranteed credit lines to the conduits and structured investment vehicles (SIVs) that were the issuers of this commercial paper had to honor those lines. Banks had used these conduits and SIVs to keep the subprime assets off their books and to avoid related capital requirements. Suddenly, those assets had to be moved back onto the balance sheets of the major banks and Wall Street firms. This required them to obtain additional funding for the conduits and to take a capital charge against the loans to the conduits—adding further to the financial system's demand for credit at a time when that credit was drying up.Hedge funds and high-yield investors also played a critical role in the cross-border spread of this market rupture. When the prices of the high-risk tranches plummeted and investors could not trade out of their losing positions, then other assets—especially those with large unrealized gains, such as emerging market equities—were sold to meet margin calls or to offset losses. Equity markets fell worldwide, and most emerging market currencies similarly fell in value, although most recovered quickly.The OTC market's lack of transparency aggravated the problem because investors, suddenly risk averse, did not know who was—and was not—exposed to the subprime risk. The high-yield mortgage securities had attracted many non-U.S. buyers. Several German banks that invested in the U.S. subprime market required regulatory intervention, and depositors made a run on Northern Rock, a bank in the United Kingdom. The seizing up of the asset-backed commercial paper market hit Canada, because the guaranteed credit lines supporting asset-backed commercial paper conduits proved to be badly written, creating legal uncertainty at a critical time. The situation was not resolved until the central bank publicly insisted that banks honor their commitments regardless of the legalities."There is more, but that's the core of the analysis. Bottom line is that a couple of things went wrong:hedge funds can be too leveraged (as any PERSON or ENTITY can be too leveraged) and if they become a major player, then look out because they have NOTHING to back up their "guarantees."banks wanted big profits but were more regulated BUT looked for ways to "slip in" better yields without PERFORMING DUE DILIGENCE--in other words, KNOWING WHAT THEY WERE BUYINGas soon as the Ponzi scheme hit critical mass (that is what it is again--amazing how so many problems can be boiled down to this age-old CON) and things went illiquid, the jig was up. It was time to pay the piper--to put your institution's money where it's mouth was all along. Another primo example of all hat, no cattle.The IMF analyst (hat's off to him, brilliant job of writing this up) didn't say what I will to draw conclusions: to me this is the INEVITABLE result of ALL countries playing with Monopoly money. Nearly 40 years ago this would have been a lot harder to pull off (and I'm not talking about the existence of hedge funds and the various entities which clearly are a facto) because there were a few countries left with something backing their money. When we went off the gold standard into the idiotic and hellish realm of the fiat money, we invited this devil into our lives. Bottom line: overuse of "leverage" (translation: all talk, nothing to back it up IF I can't find another patsy to buy my bogus investment--classic Ponzi scheme) coupled with the WILLFUL desire of "bankers" to make more money, skirting the law, by failing to do their homework, or in business parlance, due diligence.This is what we get on a macro scale from trying to run and participate in a Ponzi scheme. We see this on the microscale all the time--the gambler whose luck turns bad; the big-mouth who, when push comes to shove, can't cover his bills; the inept who buy more than they can afford and do NOT know how to understand the contracts they sign--first time some economic trouble comes to town, they tumble under because they don't have resources or financial savvy.As always, ALL of this pain was 100% preventable if we didn't have demagogues, fools, and manipulators PLAYING where people with a proper grounding in economics should be practicing BUSINESS. A proper education AND a proper MORAL grounding would have prevented the entire debacle.Still people will claim that "it's the process that counts" and "there are no right answers" and use the sandbox taunt "who sez" on moral issues and we'll see there is plenty more where this came from. We are dealing with LAWS, real ones, of economics and morality. Unlike man-made garbage, these are immutable and a slick-talking lawyer can't subvert the consequences because there is such a thing as a real LAW.
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