After being through the economic downturn since 2008, Subprime Mortgage crisis in America and how this triggered a great depression not just in US but across the whole  world, the term mortgage covered bond itself would raise lot of questions. The market for mortgage covered bonds is not just in US but across almost all countries in EURope and here there is no such negativity towards the term.

Before going any further let me try to get definition for this term Mortgage bonds. A mortgage bond is a bond backed by a pool of mortgages on a real estate asset such as a house. More generally, bonds which are secured by the pledge of specific assets are called mortgage bonds. Mortgage bonds can pay interest in either monthly, quarterly or semiannual periods.

There are number of instruments in the market MBS (Mortgage backed security), RMBS (Residential mbs) and then further specializations like interest only, principal only and on and on the further you dig deep into it you will get more specializations  specially in the US market. In the EUR market, there are not so many different specializations and the mortgage bonds is one which is used by banks or mortgage institutions to raise money for mortgages.

There are number of books talking about the great economic depression of 2008, also one movie “The Inside Job” which got best OSCAR in the documentary film category. Over the past few weeks I have read books by Michael Lewis, The Liars Poker , The Big Short ,  The Inside job by Charles Ferguson and also other books related.

Here is a scenario.  Every one of us relate Insurance to life insurance, so let us try an example say an old person with all diseases is asking for insurance, will any one give insurance – definitely NO. Now in financial world or banking, unfortunately that’s not the case, there were banks ready to give insurance that these products will not fail, and the reason why they think they are healthy is because of different financial models etc. This is a different subject to go into financial models so we shall leave that to another time.

To add another dimension to this, in banking world you can get insurance on a product even though you don’t own the product, so you are asking insurance for another old person and there is no relation to you, basically you are speculating.  Seeing that you can get insurance people started to buy product and get insurance, and no one bothered how bad the actual product is. To relate the analogy the product here is the mortgage, investment banks are happy to buy bad and Bad Mortgages as well because they can get insurance . Because investment banks are happy to buy bad mortgages, banks are even more eager to sell bad mortgages and so bad mortgages grew more and more. So the root cause to this problem is the person giving insurance on these bad mortgages. So now you may ask how much is worth of all these bad mortgages it wont be in trillion trillion, it is definitely less than that may be a few billion, and that would not cause this big economic depression.

The greed has not ended there, the banks have allowed to take any person to take insurance on these products, every one in financial world with minimum common sense have seen that Im sure this product is going to fail but the banks think otherwise, so let me take insurance or a speculative bet. The pot of bad loans is say 10 billions, there are some thousands and millions of people who took bets on this pot of bad loans. It is like another financial product and any one can buy insurance on this product. This went on for years and years and the speculative bets is in the range of trillion trillion, quadrillion, or more .

The pot of bad loans came to its end, the insurance failed and the people who gave insurance now need to pay the money and unfortunately they dont have any money now, All these years they were happy to take premiums and enjoyed good profits, now when the time comes they say they are bust and they cant pay any one, and that’s the ultimate reason for the economic down turn.

It is pure greed of the people with no ends, they could have stopped this right at the start if they had not allowed speculative betting,the product insurance is originally made to allow you take insurance on the product you own , not on some thing else which you dont own and want to take bet on that failing. And adding to that now the people selling insurance and doing this solely because they were sure they can resell it some one else more stupid and the cycle continues. There is no ethical guidelines and they are taking risk knowingly because they can sell and transfer risk to some one else.

GREED is good, to make human kind achieve higher levels of science, medical and engineering miracles and discoveries. To have greed without any ethics and with only intention to bluff is definitely the reason in this case which caused the crisis.