Securitized Trusts: Why Is King Arthur's Castle Upside Down and Owned by Wall Street?
In days of old when knights were bold the bank lent the money to the homeowner. You paid your money to the bank who never sold the note. The notes were straightforward - generally a fixed rate for a stated period of time. If you didn't pay the bank told the trustee to sell the property. There were very few defenses for the homeowner to raise because everything was uncomplicated.
Investors are always looking for a safe investment, particularly when they are investing other people's money. For example, if you are investing retirement funds you want to make sure that these funds are safe. There are not that many things that are safer than a mortgage on someone's home. Generally there had to be 20% equity in the property and the foreclosure rate was very low.
The lenders started to group the mortgage loans that they had made and sell these loans, as a group, to a trust. The trust sold pieces of the trust to investors. Enter the investor who wanted a safe investment. Sure there might be a few bad apples in the whole of the mortgage pool, but the values of homes was rising and the pool of mortgages was rated AAA. Moreover, these trusts paid more interest than other forms of investment. The lenders who sold the mortgages had already made money during the lending process and were making more money when they sold the mortgages to the securitized trusts.
Let's use an example. Joe lives in Smallville and sells firewood that he cuts from the forest. Joe has a good business and makes a nice living. Bob, the local builder, decides to start a development in Smallville. Each unit has a fireplace. Bob, being a smart guy, also sets up a store to sell firewood to the people who purchased the properties. Bob purchases the firewood from Joe.
Two years later Smallville was growing rapidly and Bob was on his third development. Fred and Jeff also developed the land, but they did not sell firewood. Everybody bought their firewood from Bob who was placing an ever increasing demand on Joe.
Instead of continuing to sell 100% hardwood, Joe started to mix some pine into the deliveries. Nobody would ever notice - and they didn't. But the forest was starting to thin out and Smallville was expecting a long, cold winter. The price of oil and electricity was rising to the point that the residents of Smallville started buying their firewood in the summer - giving Bob cash to hold the firewood. There was Bob with fists full of cash and Joe could not keep up with the orders.
