Alternative Mortgage Instrument

Finance a la shmoop what is a collateralized mortgage obligation or

CMO all right people well this is a GMO and this is a CMO yeah it's a bunch of

mortgages in one investment vehicle pot like mortgage Stone Soup not nearly as [Mortgage stones in a bowl of soup]

exciting is that that man-eating plant over there

so yeah just a bunch of mortgages that are packaged together when banks and

investors package mortgages together well they can treat them like they're a

big fat indexed bond fund because these groups of mortgages while they pay

interest ie the interest comes from the people who are actually paying off their

mortgages so why would you collateralize a mortgage obligation anyway answer risk

by packaging lots and lots of mortgages together the theory was that well as a [CMO boxes on a conveyor belt]

whole they would create a much less volatile environment than the former

alternative of having tens of thousands of individual mortgages many of which at

any given time were you know in do rest as people were dead beating and not [Man playing video games]

paying what they promised to pay back right well collateralizing this group

meant simply placing all of them into one investment vehicle that could be

bought and sold as if it were in ETF or individual closed end fund but Wall

Street being Wall Street where greed is good until it's not abused the notion of [Boxing gloves punch collateralized]

collateralized mortgages and actually applied the notion of collateral against

them pledging as collateral the equity in these mortgages or packages of

mortgages and then borrowing against them so it's like leverage on leverage,

highly volatile and this is sort of like the brilliant idea of the fraternity [Man walking along]

social chairman sending the pledges to get graham crackers marshmallows and

chocolate when he sees his you know couch is on fire yeah like why wouldn't [People carrying snacks and a couch on fire appears]

he just put it out like what was he imbibing there all right well in fact

this is more or less what happened in the mortgage meltdown of 2008 and 9 and

it was helium inside of the couch that exploded in the form of many of these [Helium explodes on a couch]

mortgages becoming insolvent and as one mortgage went bad

well it caused a chain reaction of panic up and down the economic food chain

which resulted in the near bankruptcy of the United States financial system

basically the people who pulled together these CMOS forgot what the O stands for [Man walking along the street and plant eats him]

oh dear, oh my