So you've led an angry crowd of homeowners to the doorstep of a mortgage company demanding LOAN MODIFICATIONS NOW that freeze your loans at their teaser rates forever. He says, "No can do. I'm legally bound by investors in the secondary market."

Is that true? It might not be. I don't 100% get it, but I might have made some progress today. Wanna see what I think I found? I know you do. Come along!

Harold Brubaker wrote a pretty good analysis of Collaterallized Debt Obligations today in The Inquirer, which are the means by which many mortgage holders have spread around the risk of sub-prime mortgages. I say "pretty good" because I read it three times today before I started getting my head around it. Then I went to Wikipedia and read about the darn things there.

Let me try to put it my way (which might also be wrong, but what the heck), and, more importantly, point out that these things don't work quite the way that the mortgage industry has described. In other words, a teaser freezer seems much more legally feasible than the Greedniks care to admit.

I got your clarity right here: click read more now!

OK, you might have heard in some of the press reports that it's complicated to cut a deal with homeowners on their mortgages because of the secondary mortgage market, outside investors, blah blah blah. We all knew this to be true. We knew that, for example, even if all the brokers and lenders out there making these loans have "gone bankrupt," the truth is they saw the house of cards tumbling, sold all their phony assets, made a bundle, declared "bankruptcy" and split. Poof!

There's a Pulitzer waiting for the reporter that tracks down some of these guys, I swear.

Anyway, I just didn't quite understand how they did it. That is, how they "sliced up" these mortgages and sold them in mixed parts. I just knew that the securities had been figuratively "sliced up."

Apparently, Collateralized Debt Obligations are one way of doing it that a lot of companies did and a lot of big investors bought. So let me try my best to describe how they work and then come to my shocking (armchair lawyer) conclusion. I'm going to do this in the spirit of an Econ Class, where we stick to big picture metaphors rather than the mechanics of AAA bonds and asset classes and my Uncle Lou, who can make any embarassing problem "go away" (wink, wink).

Imagine I'm a sub-prime lender that has a big fat wad of money to lend to people and wants to make his fat return, right? So he goes out and makes a bunch of loans to people that they can't afford, puts a teaser rate in there, sets a higher but unspecified rate to kick in later and checks out. The cash starts to come in as mortgage payments for him right away, but, pretty soon, as he's shady dude, he runs out of money. What to do?

Sell the mortgages? No one wants to pay enough. They look like junk. Heck, they are junk.

No, instead, he sells rights to the cash flow, in the form of mortgage payemnts. In other words, if I've made $100,000 in loans that will realize more like $300,000 over their life (with, say, $1000 monthly mortgage payment -- don't check my math, it really doesn't matter), I can sell off parts of the mortgage payments to institutional investors in ways that make them comfortable and speculators in ways that make them ... excited. I can also stick a provision in there that guarantees me a fee to manage that cash flow, whether they get paid or not.

Nice, nice, very nice. All these different home loans, in the same device.

So, for big mama-jama, UBS style investor: For $43,000, I sell rights to $90,000 of cash-flow over the life of the loan (in the form of, say, the first $300 that comes in a month until the $90K mark is reached). That part is fairly safe, right?

Okay, the community bank looking to diversify: I sell a riskier bargain. For $27,000, you $75,000 over the life of the loan (in the form of, say, $250 a month, until that reaches $75K).

To the mutual fund that comes along: for $21,000, I sell rights to $70,000 in cash flow over the life of the loan (in the form of, $200 a month, until that reaches $70K).

Lastly, to a junk bond junky: for $15,000, I sell rights to $60,000 in cash flow over the life of the loan (in the form of $150 per month until $60K is reached). Homina, homina!

Pretty awesome returns at the bottom right? I bet they are understated. Here's the deal, though... if cash starts coming in more slowly, you don't get paid at the bottom. The least risky investors at the top get paid first and when money dries up it comes out of the income of the buyers at the bottom.

Meanwhile, I've made my closing fees, got all my capital back, a $6000 profit -- free and clear, and I can make more crappy loans with fresh Capital. Or, if the market starts to look bad, I can really sell the loans off on the actual secondary market and get out of the business.

Actually, I won't be quite out of the business, because I set up a dummy company to manage my CDO for me. If you did check my math, you might have noticed that $100 of mortgage payment and $10,000 of cash flow on this mortgage isn't accounted for. What happened to that?

Why, it's going to my dummy company in fees for managing all this cash flow, of course! Silly!

SHOCKING CONCLUSION: The Wikipedia Article linked above is very clear that CDOs don't own the mortgages, they've just bought rights in the cash that comes from them. Now, we all know Wikipedia never gets anything wrong, so, let's chase that rabbit.

If all these investors have a right to is the cash that comes in, then it's presumably still at the discretion of the owner of the mortgage to decide the most effective means to generate the cash to which that mortgage entitles it and its investors? Right.

Granted, the contract could say anything. I guess I'm just trying to point out that there's an excellent chance that this whole notion of being hamstrung by the secondary market is a big fat lie.

They may have figuratively sliced up the mortgages, but the actual mortgage is still owned wholly by whomever owns it, even if they don't get to keep all the income. That person can modify loans for the teaser freezer, which probably would mean that the people at the bottom of the CDO cash-flow chain would ultimately see a lot less profit than they'd hoped.

But all they ever bought was a hope of big profits, a piece of the money that came in but market conditions showed it wasn't a'gonna come in. Hope's running out. Now the junk bond guys better see what they can do about getting their hands on a prayer.

And, CAPITALIST AMERICA: listen to me now and hear me later... TEASER FREEZERS are your only prayer.
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Philadelphia Unemployment Project
This Too Will Pass