What do you do with a massive package of adverse credit mortgages that no one wants to buy? This is the dilemma facing many financial institutions in the current economic climate. Several years ago it was easy to approve thousands of mortgages then bundle them together and sell them to a financial institution such as a pension fund which has billions of investors' funds to spend.
These days, however, the bundles of home loans that were once highly rates and gave a good return on investment are no longer in demand. The solution for mortgage lenders is to repackage the bundles and sell them on in a different form. The way this is done it to shred the old portfolios of loans which were sold on as Collateralised Debt Obligations (CDOs) and repackage them.
The adverse credit mortgages which have been prone to default in recent times are now included within bundles of other products. This means the final product which is to be sold is less exposed to mortgage defaults. Each bundle of mortgages will be subjected to some defaults as per usual in the financial services industry however in an overall sense the product will be safer and therefore should provide a healthier return on investment.
The purpose of this financial engineering is to help ensure the debt isn't subjected to a downgrade in the AAA rating that many top financial institutions require in order to buy them. Many mortgage backed bonds that were previously given the highest AAA rating now have little chance of obtaining such a rating due to the fact that too many mortgagors have either defaulted on their home loans or are at risk of doing so.
The CDO market has plummeted in the wake of the credit crunch that was fuelled by defaults on adverse credit mortgages. The half a trillion pound market in mortgage backed CDOs that existed last year has completely disappeared and has been replaced by a smaller market in repackaged securities. The result is that the credit market is experiencing a logjam which is affecting the amount of funds available to be loaned to home owners.
Whether or not the repackaged CDOs will be as popular as the CDOs themselves remains to be seen. There has been little interest in buying the repackaged products from financial institutions. This is most likely because they comprise the same adverse credit mortgages and other home loan products that are at risk of default - only they have been reshuffled into what is supposedly a more appealing deck.
It is clear to see that the market for sub prime mortgages has dried up. Lenders and investors at all levels are no longer interested in issuing them to home owners or investing in them at the highest level. Banks and other financial institutions may therefore have to look at other markets in order to keep their funds churning in future. This may include other geographical markets as the mortgage markets in the USA and EU seem to be running at full capacity.
