Here's a good summary: click. "...he began to observe both fly-by-night mortgage brokers and major banks taking what he deemed "extremely unsuitable risks," using outlandish interest-only and adjustable-rate mortgages to get customers into houses they could not otherwise afford."
"Leveraging original research on which regions, credit scores and home types were most likely to default, Burry pinpointed hundreds of tranches he believed were most vulnerable to a potential wave of foreclosures and defaults. But there was still no way to easily short-sell these tranches, so he asked the broker-dealers who handled his derivatives accounts to let him know when such a method or instrument was created."
"In mid-2005, Burry's contact at Deutsche rang to say that the bank's credit-derivatives desk had decided to offer credit-default swaps on those subprime-mortgage-backed tranches. A credit-default swap is essentially an insurance policy that pays off if its targeted instrument -- a tranche, an entire mortgage-backed security, a collateralized debt obligation or a company -- goes belly-up. Buyers must pay an annual premium, at a rate set by the marketplace, for a contract that pays $10 million, for example, in the case of a default. The buyer can continue to pay the swap premium for years waiting for an expected default, or he/she can sell the swap at a profit to another buyer.
European and Asian pension fund managers hungry for yield at a time of low global interest rates were avid buyers of the type of insurance-premium income that Burry was paying. Because the subprime tranches were rated investment-grade, the buyers thought they were relatively safe and thus were getting money for nothing."
"In contrast, Burry thought it was nuts for someone to take the other side of these trades, believing that in two years enough borrowers would default to make the swaps trigger a payout. If he paid $130,000 a year for the swap for a couple of years, he figured that a $10 million reward was an awesome deal. You could make 12 to 30 times your money -- or more if you borrowed the money that you used to make your payments."
It's going to be a tough few years for real estate. It might be a good time to pick up that vacation home or rental property.
3 comments:
Unfortunely the realestate industry will be seeing a major slump for sometime.I knew realtors that had used the sub-prime industry as a way to sell homes and never mind if the buyers could afford the loans A.R.M. The mortage industry and the need to keep making sales at all costs have gotten us into a big mess,now I'm afraid the the industry will have to do some real soul searching at look out for their clients more that makeing the sale.
I think the FBI and the SEC are about to roll some heads. I saw one figure at about $150 billion lost connected with subprime lending and a couple of other bad loans. Things are going to be a lot different in real estate for the next decade or two.
Endymion,I totally agree that the realestate industry will be changed.for how long that is up for debate. It all boils down to how much you are going to be upstanding and put you clients first.I know that is what I tried to do when I was a realtor.I would never direct a client to a subprime lender,even if it meant that I would lose a client.I had to be true to my beliefs that the client came first and sales came after that.
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