How the Free Market Mortgage Bond Scam Works

This is a great little article by Michael Hudson about how the US government is un-freezing the credit markets by gifting money to the banks.

"Suppose a bank is sitting on a $10 million package of collateralized debt obligations (CDOs) that was put together by, say, Countrywide out of junk mortgages. Given the high proportion of fraud (and a recent Fitch study found that every package it examined was rife with financial fraud), this package may be worth at most only $2 million [...]" [Note also that without the possible fraud and the leveraging such CDO losses should be no more than the average real estate price fall.]

"The bank now offers $3 million to buy back this mortgage. What the hell, the more they bid, the more they get from the government. So why not bid $5 million. (In practice, friendly banks may bid for each other's junk CDOs.) The government – that is, the hapless FDIC – puts up 85 per cent of $5 million to buy this – namely, $4,250,000. The bank only needs to put up 15 per cent – namely, $750,000.

Here's the rip-off as I see it. For an outlay of $750,000, the bank rids its books of a mortgage worth $2 million, for which it receives $4,250,000. It gets twice as much as the junk is worth."

At that point it would also be interesting to see what the rules are about how much the FDIC gets back once (if?) those CDOs are untangled and any underlying assets realized. Of course, as I've said before, if the bonds were highly geared they could be worth less than zero.