What happened in the 2008 Financial Crisis was terrible for millions of people. Watch the video below to find out why.
Video from cashmoneylife.com
After viewing the video above, I had one thought: CDO's are extremely complicated!
Buying a note is somewhat similar to buying a house. You get time to do due diligence; you can “inspect” the note to see if the borrower makes payments regularly, and get a good estimate of the current value of the house.
Once you buy the note, you as the lender are in control if the borrower stops paying. You can foreclose and resell the property, or you can give the borrower an opportunity to get back on track with payments and stay in their home.
It’s just less complicated to buy a note directly. With collateralized debt obligations (CDO’s), the investors had no way to contact the borrowers and work out a plan to get them repaying.
They had no details on the borrowers or the property. They had no way to recoup their investment because instead of buying notes directly, they bought slices of a bunch of notes with no information about how the notes were created, no clue about the way the borrowers repay the loans, and no way to know how to contact the borrowers to attempt to get them to repay.
There is some similarity to owning a note and owning a rental property. Landlords have a vetting process: the standard rental application ensures that tenants pay bills regularly and that they have enough income to pay the rent.
Mortgage lenders should and do require an application to ensure that the borrower can pay as agreed, and can handle all aspects of property ownership. If they can't afford the mortgage, they are not likely to be able to afford to keep up with taxes, insurance and home maintenance issues.
The people who invested in CDO's did not own the notes! While they did not have to manage the notes directly, they were not in control of the properties when the notes defaulted.
Why buy a mortgage where the borrower could not afford the payments? Why would any lender create a loan that is a ticking time bomb? These people that created CDO's were looking for a quick buck.
Would you rather have a fast dollar or a steady stream of them? Comment below.