I am getting tired of statements like these from Steve Eisman:
But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says.
Wrong wrong wrong. The problem is not that it isn’t possible to turn “BBB” subprime loans, in part, into risk-free ”AAA” securities. The problem is that it was not done correctly. If you take a pool of $100 million in subprime loans, you could easily make the most senior 20% into AAA securities that don’t take a penny of losses until the other 80% of the bonds take a complete loss. Even the worst subprime pool, generally California Countrywide and WaMu loans from 2006, where defaults will probably reach 70 or 75%, if the bonds had been written like this the AAA tranches would still be completely safe.
The problem was that too much of subprime pools were cut up into tranches rated AAA. Instead securitizing the 20 or 30% of the pool into AAA bonds, instead the amount was more like 75-85%.
I’m all for attacking the corrupt, greedy, fraud-ridden mortgage finance industry. But doing so does not require overstatement. AAA-rated bonds backed by subprime mortgages can be safe investments. The problem was that those who actually created these bonds (investment banks and the rating agencies) were extremely reckless and/or dishonest when they were making assumptions about future loan losses.
