The Epic American Credit and Bond Bubble Laboratory Message Board

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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory

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To: John Vosilla who wrote (93418)	4/10/2008 3:54:44 PM
From: Sun Tzu	Read Replies (3) of 110194

BTW, I don't know how much of the mechanics of the problem you know, so here is my understanding of the issue. You borrow $1M to buy house (forget about subprime for now). The bank gives you the loan and securitizes the mortgage as AA bonds. I buy your $1M bonds and use it as collateral to borrow $10M. The bank securitizes that $10M again sells the bonds around, this time as BBB to AA rating, depending on who I am. The process repeats itself again, likely involving derivatives to help insure the contract. But even if we exclude credit derivatives (and that can really multiply the notional value), you see how doing this process few times is enough to increase the money supply by orders of magnitude. Now if the original mortgage fails, then the rug is pulled from under the whole thing and dominos start to fall. Incidentally, I’ve heard some people claim that a gold standard would have prevented this type bubble. Nothing could be further from the truth. This has nothing to do with fiat or gold currency. It has everything to do with banking regulations and rating agencies.

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