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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: philv who wrote (37481)	8/1/2005 11:40:24 AM
From: Ramsey Su	Read Replies (2) \| Respond to of 110194

Message 21560066 read the bottom link.

To: philv who wrote (37481)	8/1/2005 11:56:30 AM
From: J_Locke	Read Replies (2) \| Respond to of 110194

Hedge funds have become the enablers of the mortgage finance bubble. They are the marginal buyers of the low-rated mortgage derivative tranches (using mostly borrowed money, of course). Greenspan lowered the bank reserve rate in 1990 to bail out the banks after the S&L crisis. He then changed the sweeps rules in 1995, which in essence lowered the reserve requirements even further. So, we have very low bank reserve requirements. Banks can therefore do a lot of mortgage lending. However, demand for mortgages is so strong that, even with the low reserve requirements, banks would have to increase their reserves to meet all the demand. They would have to raise their CD and money market rates to attract new deposits. They don't want to do this because (a) it hurts their net margin and pressures profits, and (b) when banks are competing for money it puts pressure on the entire interest rate complex, raising interest rates and choking off demand for new loans. So, what do they do? Instead of increasing reserves, they manage their reserves by selling off mortgages into the MBS market. But who wants to buy all these crappy loans in bubble markets? Not the GSE's, who've been ordered to cut back on their activities. Enter, structured finance. Package the loans together, cut them up into "safe" senior tranches that pension funds can own and risky, low-rated tranches. But who buys the low-rated tranches? Why, hedge funds, of course. Using money they've borrowed from some of the same banks that are originating the mortgages in the first place. Structured finance only works as long as there's a marginal buyer for the low-rated tranches. That's why Greenpan loves hedge funds. They create the disconnection of demand for credit from the price of credit, and allow the perpetual motion machine to keep on spinning.