Flip through the latest issue of Gulf Weekly.
Twelve Steps to a global financial crisis. How does an ordinary mortgage turn into a disaster for the financial market?
l. John Doe gets a mortgage that requires no down payment and no proof of income.
2. His mortgage bank parcels his debt up with thousands of other similar debts.
3. An investment bank buys these parcels and securitises them by selling them on to other investors as ‘asset backed securities’ (ABSs) or ‘collateralised loan obligations’ (CLOs). The mortgage bank uses that money to make more loans to other John Does.
4. ABSs and CLOs are bought by other banks, hedge funds, pension funds, insurers and other investors.
5. Hedge funds and other investors leverage by borrowing as much as 10 times the value of these securities from banks as a way of betting on changes in their value. If they get it wrong, the leverage means losses multiply.
6. John Doe can’t pay the mortgage and, because house prices are falling, can’t sell the house either.
7. Defaults on the ABSs rise and their value falls.
8. Banks start calling in the loans they made to hedge funds.
9. Hedge funds and other investors try to sell their ABSs to repay loans. Their value falls further.
10. Hedge funds and other investors are forced to sell shares and other assets with a more liquid market instead.
11. Banks refuse to buy any more mortgage debt.
12. The mortgage bank has no money to carry on its lending business.
