Lew Ranieri regrets creating the CMO
“‘I’m the guy who played a central role in this home thing and I regret it because…it got abused beyond everybody’s imagination, ‘” says Lewis Ranieri, creator of the collateralized mortgage obligation (CMO), according to the Wall Street Journal.
Ranieri’s creation of the CMO was nifty financial engineering by a sophisticated Wall Street investment banker that revolutionized the home mortgage market. But the CMO ended up being a financial weapon of mass destruction that crashed the global economy in 2008. The CMO brought us the Great Recession, from which we are still recovering.
What are CMOs?
CMOs permitted banks and other lenders to make more money because they could sell mortgages to Wall Street. Before the CMO, mortgage lenders had money tied up in each individual mortgage they made until it was paid off. Lenders also bore the risk of each individual mortgage until it was paid off.
The creation of the CMO meant that lenders could sell mortgages they made. This permitted the lenders to use that money to make more mortgage loans — earning more fees. Lenders loved that they could make many more mortgages, thus earning much more in fees.
Boring mortgages became the new big thing on Wall Street because they were a fee-generating bonanza. Wall Street packaged mortgages together and sliced them up into tiers (tranches) of risk. Each tranche was a separate CMO or mortgage bond. Wall Street earned substantial fees to create CMOs.
What could go wrong?
The Wall Street investment bankers who were creating CMOs were hell-bent on making as much in fees as they possibly could. That meant churning out high grade CMOs even when the mortgages in those CMOs were high risk. At best, they fooled themselves into believing that these packages of subprime mortgages were diversified. More likely, they knew that the subprime mortgages in CMOs were not only risky but highly correlated — meaning the same events that would cause one mortgage to default would cause other mortgages to default. But identifying them as high risk would mean many investors would not purchase them.
Wall Street overcame this problem by figuring out a way to convinced others that its financial engineers could spin a silk purse from a sow’s ear. By slicing and dicing those packages of subprime mortgages, Wall Street created what it claimed were high quality CMOs. But Wall Street could not simply claim they were high quality. Wall Street needed someone independent to rate them as high quality.
Each CMO had to be rated by an “independent” securities rating agency — like S&P, Moody’s, or Fitch. That should have been a check on Wall Street, but it is only if the ratings agencies do their job. They did not. Ratings agencies gave CMOs high ratings willy-nilly. Ratings agency employees who raised concerns were told to shut up. The ratings agencies got hooked on fees they were receiving from the Wall Street CMO creators so they gave high ratings to high risk CMOs.
In the end, you and I and many other people invested indirectly in CMOs. CMOs were purchased by mutual funds that were held in retirement accounts like IRAs and 402(k)s. CMOs were also purchased by public and private pension funds — injuring thousands of US workers.
As we reach the 10 year anniversary of the crash of the global economy, we should think back on how easy it is for this to happen again. In fact, it is already happening.
Lisa Bragança recovers losses for investors all over the country, protects whistleblowers, and defends individuals and businesses in government investigations. As a Branch Chief with the SEC Division of Enforcement, Lisa conducted and supervised insider trading investigations and a wide range of investment fraud and Wall Street misconduct.
You can reach Lisa at (847) 906-3460 or Info@SECDefenseAttorney.com. www.SECDefenseAttorney.com
Disclaimer: This information is for general purposes only and should not be interpreted to indicate a certain result will occur in your specific legal situation. The information on this website is not legal advice and does not create an attorney-client relationship.