Certain CDO investors (foreigner and American alike) weren’t so dumb after all.
It turns out that the creators of mortgage back securities such as Citigroup issued money-back guarantees ($25 billion worth at Citi alone). So we’ll see more write-downs at the big American banks.
A closer look at the mortgage meltdown reveals Citigroup (C) and other big banks offered a type of money-back guarantee to buyers of nearly $100 billion of subprime mortgage-linked securities, according to a BusinessWeek analysis. Incredibly risky in retrospect, the refund policies were critical in the banks’ push to keep a steady stream of money coming in during the peak years of the housing market from 2004 to 2006. But the myopic decision has been a central cause of the billions in losses that some banks are now reporting. Citi, which declined to comment, announced on Nov. 5 that it was on the hook for $25 billion worth of such deals.
HIDDEN LIABILITIES
Here’s how it happened. Money-market funds eagerly bought up the short-term debt associated with the subprime-linked securities known as collateralized debt obligations (CDOs). The refund policies, technically known as “liquidity puts,” were crucial. For instance, they allowed the credit rating agencies to bestow on the investments the same grade they gave the banks that backed them. That reassured the funds.
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