Bank of America. Countrywide Financial Corporation in itself does notfund the loan through its deposits, instead it securitize's the loan, andsells it to Wall St investors, hedge funds and commercial banks. Theinvestors used to get dividends on mortgage backed securities in theform of monthly installments which the borrowers of loans used to giveto the banks.A pooling of mortgage only related loans is called as
akin a bond
.Collalterized Debt Obligation
(CDO)– this can be defined as apooling of not only mortgage related loans but also credit card loan of family X , subprime loan of family Y and so on.
Here is a small example
A CDO is bought by a bank in Norway; the bank does not know itsassets. I.e. it does not know the underlying asset of the CDO.It knows the CDO is rated AAA by Moody's. Alls well until the "asset"backing the securitized product hits a wall. I.e. there may be default ininterest payment by the borrower. So the bank in Norway has to writedown the value of such assets which reduces their capital ratio and inturn affects their ability to give loans.
One question that you might get is by packaging and sellingthese MBS’ and CDO’ how does CFC and BOA get affected?
- One thing to note is that the deposit money that is lended out tothe borrower is not of Countrywide Financial Corporation but it is of BOA. So Countrywide Financial Corporation only sells the loan to us. Itacts like an intermediary. It sells the loan to us at a rate of interestwhich is higher than rate of interest at which BOA sells. The differencein rates of interest is CFC’s profit .CFC also gets a good commissionout of the securitized product (MBS) that it sells on Wall Street. All wasperfectly fine until defaults started happening and because of defaultsthe portfolio of securitized products of Countrywide FinancialCorporation reduced in value and it had to further bear the losses of the defaults that were taking place in home loans. All this had acascading effect and Countrywide Financial Corporation and Bank of America suffered huge losses.Home loans in 2008 were so divided and spread across thefinancial spectrum, it was entirely possible a given homeowner couldunwittingly own shares in his or her own mortgage. A person whobought a new home in January 1996 for $155,000 could reasonably