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The analyst who cut the line
Chad Cascarilla had spent time in high yield investment banking at Bank of America before Goldman hired him as an analyst. He was supposed to join the technology analyst in research, an obvious dream job for someone who had been buying tech stocks his whole life.
Instead he went to work for a financial services analyst and ended up covering the odd, off-the-run names: mortgage guarantee companies, Fannie and Freddie, thrifts, and credit card companies. These were companies he had never heard of.
It looked like a sad detour away from technology, where he had spent his investing time. Some of the bond guarantee companies he covered, AmBAC and MBIA, blew up later.
How did bond insurers like MBIA make money?
Companies such as Ambac and MBIA, which began in the 1970s, insured municipal bonds and charged an upfront premium. Their top credit ratings were attached to the bonds they guaranteed, so a town could borrow at a lower interest rate and the savings paid for the insurance. The model depended on defaults being very rare, which kept payouts small compared with premiums. In the 2000s they expanded into guaranteeing structured securities backed by mortgages.
Why did Ambac and MBIA blow up?
Both guaranteed securities tied to subprime mortgages, including collateralized debt obligations, and losses on those guarantees exceeded the capital they held. Credit rating agencies downgraded the insurers in 2008, which also lowered the ratings of the bonds they insured. Ambac Financial Group filed for Chapter 11 bankruptcy protection in November 2010.
How do Fannie and Freddie lower mortgage costs?
Fannie Mae and Freddie Mac buy mortgages from lenders, bundle them into securities, and guarantee investors will be paid even if borrowers default. Because investors have treated that guarantee as carrying an implicit government backing, they accept lower yields, which reduces mortgage rates. Congress chartered Fannie Mae in 1938 and Freddie Mac in 1970. Both were placed into federal conservatorship in September 2008.
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