04282010charleston_sc_home_foreclosures_for_sale.jpgWould a poo sandwich by any other name smell as sweet? How about if you wrapped a poo sandwich in a prospectus and called it a collateralized debt obligation? Would that make it smell better?

The kindly, loveable and warmhearted Wall Street investment bank of Goldman Sachs thought so. The Federal Securities and Exchange Commission begs to disagree. The elephants from Wall Street and Washington, D.C., are fighting each other in the legal tall grass and the pygmies of Main Street will get trampled as usual. The SEC has sued Goldman Sachs for civil fraud in the sale of a colorful fi nancial product called a subprime mortgage bond.

Have your eyes glazed over yet? If you are still awake, let us consider the strange case of the red-headed poster child of the fi nancial collapse, the bouncing baby subprime mortgage bond market. Where do subprime mortgage bonds come from? Why, from the fi nancial Easter Bunny. Making a mortgage bond is easy. Mortgage brokers, banks and other lenders lend money to borrowers who mortgage their house and sign a note promising to pay the money back or lose their house.

If the home owners are less likely to be able to pay back the money they borrowed, these are called subprime loans. These lenders don’t care if the borrowers can pay the money back. The reason the lenders don’t care about repayment is that they are not trying to collect any money from the broke borrowers. The lenders sell these lousy loans to Wall Street fi rms and collect a fee. The Wall Street fi rms slap a bunch of these subprime loans together in a big pile called a subprime mortgage bond.

Think of a subprime mortgage bond as a poo sandwich. The poo sandwich is piled high with zillions of bad loans. Wall Street then sells these poo sandwiches to investors like insurance companies, pension funds and local and state government agencies who theoretically ought to know better than to buy a poo sandwich but do not.

Wall Street doesn’t have to collect the money from the borrowers either. Wall Street gets paid for making the poo sandwich. It gets paid for selling the poo sandwich.Wall Street sold poo sandwiches to investors who hoped to collect mortgage payments from borrowers who couldn’t afford to repay their loans. Hope is not a plan.

Surprisingly Wall Street got greedy. It wasn’t enough to sell regular poo sandwiches. It began to sell poo sandwiches that were so rancid that Wall Street invented a type of insurance that would pay off if the subprime mortgage bond in the poo sandwich defaulted due to nonpayment by the homeowners. This insurance is called a “credit default swap.”

Wall Street made lots of money selling credit default swap insurance to the ultimate buyers of the poo sandwiches in addition to selling the subprime mortgage bond. Selling credit default swap insurance was like selling fries with a poo sandwich. As long as the housing market kept going up, homeowners could repeatedly refi nance their mortgages into new subprime loans. The poo sandwiches kept selling. Wall Street didn’t have to pay off the credit default swap insurance and got to keep the insurance premiums.

Wall Street had a curious rating system for the credit worthiness of poo sandwiches. If your sandwich smelled too bad, for a fee a pliable bond rating service could rate your poo sandwich as tastier than it actually was.

Then a funny thing happened. Housing prices collapsed and homeowners stopped paying their mortgages. The wizards at Wall Street who had been writing credit default swap insurance on poo sandwiches morphed overnight into fi nancial dummies who suddenly had to pay huge sums of money to the even smarter guys who had bought the credit default swap insurance on poo sandwiches. Some of the Wall Street fi rms didn’t have enough money to pay off their credit default swaps and woke up dead like Lehman Brothers and Bear Stearns. AIG Insurance happily sold credit default swaps on poo sandwiches and would have collapsed if not for the government bail out of Wall Street.

The emperor had no clothes. We knew that Wall Street had no morals but plenty of poo sandwiches. It turned out Wall Street had no brains either.

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