Why Bain Killed Good Companies and Good Jobs - I Break It Down

[jmowreader]

39. LBO financing isn't done by conventional banks

How everyone except Ted Forstmann finances an LBO is through the sale of high-risk securities. In the old, old days, when Michael Milken and the Masters of the Universe were raping companies, they wrote high-yield bonds (named 'junk' bonds by financier Meshulam Riklis) against the company's assets. A company named Drexel Burnham Lambert would write...oh, say $10 billion...worth of these things and sell them to the financial division of the More Balls than Brains Club. In those days, you could write a junk bond that didn't pay its quarterly interest installment in cash but rather in more junk bonds. (This was a "pay in kind" security.)

Romney came into the business after they threw Milken in prison, Drexel was liquidated and the market for junk bonds no longer existed. To replace them, they used a derivative called the Collateralized Debt Obligation. How it works:

Mortgages, as you know, are salable. Once XYZ Mortgage loans John and Sally Jones $250,000 to buy a house, it sells the contract to a servicer for its face value. The servicer then collects the payments and keeps the interest.

That's all well and good but the servicer will need more money to buy more mortgages so it takes all the mortgages it bought over the last month or so, evaluates each one for creditworthiness, and puts them in two piles: "safe" and "risky." It then sells bonds called "mortgage backed securities" against each pile. The "safe" MBS gets sold to insurance companies and pension plans as an investment-grade bond. The "risky" MBS gets held onto until there are quite a few. When there are enough, they put them in a pile and write more bonds against it; these bonds are called Collateralized Debt Obligations. Because the underlying securities are high-risk MBS, they are sold as high-yield investments--the junk bond of the new millennium. This can be done by a brokerage, and usually is--no commercial banks need be involved. (On edit: they USED to put the loans into piles according to creditworthiness. These piles are called "tranches." Now they just throw all the mortgages in a gunny sack, declare that half of it's safe and the other is high-risk, and sell the different riskinesses of MBS anyway. This means that you as the derivatives buyer for Stay-At-Homers Insurance (what you buy when you don't want Travelers Insurance, right?) could very well buy $25 million in investment-grade MBS and have two-thirds of its value evaporate because the underlying mortgages defaulted...which ain't supposed to happen, kids.)

These high-yield CDOs are what Mitt Romney used to finance his takeovers, and he was aided by George W. Bush, who signed a law (the American Dream Downpayment Initiative) enabling low-income persons to buy homes using subsidized down payments.

It gets more fun: Because this paper is very high risk, most investors do not want to buy it if they think there's a good chance they'll lose their investments. One might say CDO investors are seated in the crazy-not-stupid section. They therefore purchase a kind of insurance policy called the credit default swap, which is a derivative in its own right. It is not really insurance; the seller doesn't need to have the money to pay you back, and the buyer doesn't have to own the covered MBS or CDO. Because of this, you can create a whole NEW kind of derivative called the synthetic CDO by purchasing a lot of naked CDS and tranching them into bonds. And of course, you can sell this derivative for money to buy and rape companies with.

This is why I have said, and I will continue to say, that Mitt Romney caused the mortgage crisis.