Remember I said that in 1934, the United States government decided to insure mortgages of a certain kind through the FHA, Federal Housing Administration and later through the Veterans Administration for veterans, the government would merely tell the mortgage lender that if this guy defaults, it will pay up so don't worry. So these people- they wanted to make sure that people who fought in the war and came home wouldn't be handicapped by their being out of the business world. That makes sense. Right? Veterans should get some special preference but that too- private companies that also did insurance on mortgages. And then you pay for it. So, when you get your first house, you'll have a mortgage payment that subsumes the PMI, private mortgage insurance. And that ensures the lender but you have to pay for the insurance. You the homeowner, pay for it. If the down payment is less than 20 percent of the value of the home, and it usually is. Now, there is a controversy. This is more manipulation and it's not really deception, it's failure to notify you. You would think that the mortgage lender or the mortgage insurance company would notify you when the value of your house is probably over 20 you know, value of your house went up. So now, the down payment is- your mortgage balance is less than 80 percent of the home value and tell you to cancel, but they don't. So, many people continue to pay for PMI long after it was necessary. That's capitalism. They have no incentive to notify you. They also didn't necessarily hold enough reserve. So in a financial crisis, at least one of them, PMI Group Inc. declared bankruptcy. So insurance companies are not necessarily reliable. So, the CMO is a, I think I was starting on this last time, it's a- when a bank issues a mortgage, it's a loan so it's a piece of paper with a certain value, they can sell the mortgage to somebody else and typically continue as the servicer of the mortgage namely, you send your mortgage check to them and if you don't pay, you get a call from them or from someone they subcontract to call you. But the owner of the mortgage is different, now it's an investor. A CMO is a collateralized mortgage obligation that is a pool of mortgages that is sold to investors like you, you could invest in one of these. But they also divide them up into tranche, and I think I alluded to this. The senior tranche gets paid first. If there are defaults, it affects the senior tranche only if all the other tranches have been wiped out. So they might have a AAA tranche, then a AA tranche and so on that are not rated as highly. And it helps them sell these securities because many investors are required by their charter or their sense of obligation to invest only in AAA things. So, CMOs- an ordinary of securitized mortgage would not have a AAA rating, because the homeowners might default. But if you divide them up into tranches like that, you can get AAA securities out of them. The last tranche, the worst one is called toxic waste. And these are the ones, it's probably not worth anything or very likely not worth anything. And hedge fund investors might buy those if they are- at a price, really low price so they take all the risk. But presumably, they understand it better than you, the investor. So what is a CDO? It's something like that, does the same thing, it divides it up into tranches. You might think of CDO is just a more general category. They don't have to buy just home mortgages, they can buy auto loans or any kind of debt. There's also some technical legal definition that I won't get into because this isn't the Yale Law School. Both CMOs and CDOs went into default, they reached into the higher tranches during the financial crisis and that was- I said 2007, it's 2007, '8, '9 maybe '10, '11. Maybe even now we could still say we're in it. I don't have a good name for it. But what we do know, is that these these CDOs and CMOs dropped in price. Actually, they dropped in price too much. The AAA tranches shouldn't have been rated AAA, but they weren't as bad as all that either. People panic because of the crisis. So it was a good investment in 2009 around then, to buy low priced CDOs and CMOs. You have to be smart. Once again, I don't believe the efficient markets hypothesis that everything is priced right, especially at a time of crisis when everything seems up in the air. And this is a time when deep knowledge of institutions and people help you. You have to kind of be in this swim of things, know what's going on in Wall Street. Know in 2007 that those ratings that the rating agencies gave are bunk, so you don't buy them. After they're beaten down, then you go and buy them because you know it's not that bad. So that's how the smart money outperforms.
