Bank of America Corp (NYSE:BAC) – the MBS boom to bust story
Today, Bank of America Corp (NYSE:BAC)’s Chief Risk Officer, Terrence P. Laughlin, testified that the negotiations with the bank’s institutional investors, that have resulted in an $8.5 billion mortgage-bond settlement had an undercurrent of aggressiveness and were very tense. The initial meetings with the investors who had brought claims against BAC for breaches of warranties and representations were extremely tense and both sides held onto their horses. The subsequent settlement talks were adversarial and contentious Laughlin said that he had got pretty upset as he felt that the investors were not negotiating in good faith.
In 2008, the U.S was teetering on the cliff of financial disaster. Unemployment seemed to have reached it two decade peak. Hoards of homeowners were defaulting on their loans in. The well-established big investment banks that had been conducting business for over century and had risen from the ashes of the Great depression now faced collapse. In other words, the U.S economy was spiraling downwards. And at the core of this economic disaster was the financial instrument- the mortgage-backed security.
What are MBS?
Mortgage-backed securities or MBS are merely shares of a home loan that have been sold to investors. This is how they work- A bank lends money to a borrower to purchase a house and collects the monthly payments on this loan. On many occasions, these loans are sold to a much larger bank. This bigger bank bundles these loans into what is called a mortgage-backed security. Shares of the security, “tranches”, are then issued by the larger bank to various investors. The investors ultimately rake in the dividends in monthly mortgage-payments form. Additionally, these tranches can be repackaged and resold as other securities. These are referred to as collateralized debt obligations or CDO’s.
Then and later…
In2008, home loans were divided and also interspersed across the financial spectrum and were a safe and ideal method of making money when there was a boom in the housing. And that’s exactly how things were in the early part of the 21st century. It was a definite possibility for a person who had paid $155,000 for a home in Jan 1996 to sell it in Aug 2006 and rake in a profit of $100,000. However, 2008 was not 2006; the housing market in the United States crashed and turns out, that the mortgage-backed security was the one who wielded the hammer.