It was huge returns in the eyes of the lenders.
They often leverage 10 to 1.
When 5% was a market rate, getting 7% was 40% more, that’s huge to them, however on risky 2nds, they were getting up to 12%..
Alot of the risk was laid off to average investors, without them understanding the risks. Say that a Wall Street fund manager was given $100 million by investors. With that he could leverage $1 billion in mortgage loans.
He might get paid 2% off the top, so $2 million to start in his pocket.
The returns were then based on $1 billion, until the subprime defaults started.
Subprime bonds were risky to begin with, but Wall Street got VERY creative and carved them into tranches. So there were A rated bonds that were the “best” of the worst.
The rating agencies rated these bonds incorrectly!
Several of these hedge funds were declared worthless a few weeks ago. (Bear Sterns I think) The investors in these funds will probably get zero.
There are individual funds, pension funds and city governments that will be taking losses that they are not aware of yet.
It happened with junk bonds in the 80’s. Funds lose everything because of the leverage.
In the quest for higher returns, risks are taken. The fallout won’t be known for awhile, as they will lag in reporting the bad news as long as possible, and hope to offset with other returns or sweep it under the rug.
