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Aug 2, 2006
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If you read this try to smile....


Let's say I won the powerball lottery for the sake of this fictional and humourous discussion and I am drinking a Bud Lime.

I bought 1,000 mortgages, each having a face value of $250,000 collateralized by approximately $300,000 worth of residental real-estate. When added together the sum totals $250M with documented appraisals for $300M. I make nine piles of paper mortgages on my breakfast table, beside my bacon and eggs, and label them A+, A, A-, B+, B, B-, C+, C, and C-. Think of these stacks as paper grades in college. Each letter and possible positive or negative sign correlate to risk, so I assign 5%, 5.5%, 6.0%, 6.5%, 7%, 7.5%, 8%, 8.5%, and 9% annual returns to the related stacks. Think of these percentages as paper EPD number accuracies. The stack of A+ mortgages are the same stack as the 5% stack and carries the least amount of risk and the least amount of return. Likewise, the C- stack of mortgages is the same stack as the 9% stack and carries the highest amount of risk and the hghest amount of return. You get the idea. My nine down payment stacks...well, we won't talk about these green paper stacks for now...let's just talk about derivatives...

I look at these big stacks of white paper and I get this brilliant idea. It is only paper and not the real actual house! I can sell these paper stacks on an organized market and fill most size orders and risk appetites under $250M to institutions, make a tidy little profit up front, get my hard earned money back, and do it all over again. After all, how many institutional buyers do you know that don't believe in paper? For a fee, I only charge 2% up front for a $5M green paper commision and could take me about one week to unload, then I start all over the next week. In case you are interested, let's say I make about $1M green paper per day not counting the down payments on the other 9 stacks. So I create 9 traunches each having a binding risk and reward. Then another brilliant paper idea overcomes me. I figure I can combine these white paper traunches to fit any paper return a participant wants! I can mix and match! I might initially sell one for $10K that returns 8.125% and another for $1M than returns 6.875%. It doesn't matter how much principal paper one wants or what paper percentage return is wanted as long as they provide the green paper. I can fill the order! However, how am I going to split the actual mortgages up and mix and match? Then the answer came to me like the smell of bacon...easy.....I simply call the split mixes and matches of mortgages a new security type...CDO for collateralized debt obligation.

I can let the electronic over the counter market determine what the CDO securities are actually worth through supply and demand. And then all of the sudden it hits me. I can offer derivatives of the collaterlized debt obligations. So if one investor wanted $100K paying 7.25%, the exact same investor could simultaneously buy a put contract, which states if the split mix and match traunch defaults, the put premium covers the defaulted investment. Therefore, the $100K investment returning 7% face value, before trading on the exchange, might only net 6% after paying the insurance premium price. The seller of the put contract then gets the investor's premium but has to own the security under control. So you can see more clearly, I call this put seller AIG and the put buyer CALPERS. I am going to pat myself on the back for this heroic idea because every poor person is the world will have a place to call home and not just the Wall Street braggarts and bankers living in mansions. I just invented market derivatives of collateralized real-estate traunches so pension and retirement plans can invest their trillions and trillions of dollars and hedge their position without having to worry about being involved in a lawsuit. What is so exciting about this whole system is, each transaction is a zero sum transaction, where there is always and exactly one winner and one loser.

Excuse me, I was chomping on some here comes Rosy Kate while I look out my breakfast table registered cow with high profit indices. I have 15 stacks next to the 9 stacks of mortgages. One stack is for BW and the next stack is for WW, etc. Each stack represents an EPD. Her BMI$ profit index is the highest in the world so I put a copy of her paper registration certificate on the top of the 11th stack. You may ask..."why do you think her $BMI index is the highest in the world?" It is only paper and not a real steak on a come-on be real because this is real life! We can call it a paper steak on a plate if you would like. Was it because she had the lowest BW EPD number and the highest WW EPD? Or could it be a combination of all the EPD numbers or maybe half of them. Heck, I don't know how much IMF, FAT, or REA is calculated in the formula. What I do know, is her blocky looking bull calf sucking on her pert teats inherited half of these great paper numbers on stack 11 that the scientists and mathematicians claim to be predictors of future performance...not real world steak on a plate. The question becomes, is the profit index become green paper or white paper?

Now then...what kind of paper return are you or white?