The investor in home loans didn’t know how long his investment would last, only that he would get his money back when he least wanted it. To limit this uncertainty, the people I’d worked with at Salomon Brothers, who created the mortgage bond market, had come up with a clever solution. They took giant pools of home loans and carved up the payments made by homeowners into pieces, called tranches. The buyer of the first tranche was like the owner of the ground floor in a flood: He got hit with the first wave of mortgage prepayments. In exchange, he received a higher interest rate. The buyer...
Note: test note!
The purpose was to extend credit to less and less creditworthy homeowners, not so that they might buy a house but so that they could cash out whatever equity they had in the house they already owned.
The mortgage bonds created from subprime home loans extended the logic invented to address the problem of early repayment to cope with the problem of no repayment at all. The investor in the first floor, or tranche, would be exposed not to prepayments but to actual losses. He took the first losses until his investment was entirely wiped out, whereupon the losses hit the guy on the second floor. And so on.
Now Eisman had his first exchanges with them, and what struck him immediately—and struck Danny and Vinny, too—was the caliber of their employees. “You know how when you walk into a post office you realize there is such a difference between a government employee and other people,” said Vinny. “The ratings agency people were all like government employees.”
Note: ouch. not exactly PC.