Asset-backed Commercial Paper
A short-term IOU issued by companies with a promise to repay the loan. Often backed by bundles of mortgages, credit cards payments or car loans. The Canadian asset-backed commercial paper market froze in August 2007. This caused large institutional investors such as Caisse de dépôt et placement du Québec (the province's biggest pension-fund manager) and the City of Hamilton to take multi-million dollar losses. It was an early warning sign of the coming meltdown. Collaterized Debt Obligations (CDOs)
An investment constructed out of bundles of debt, like Residential Mortgage Backed Securities (see below). "CDOs were the epicenter of the upheaval, the device that magnified a what otherwise would have been contained subprime bubble into an economy-wrecking meltdown." - Yves Smith, author of ECONNED
Credit Default Swaps (CDSs)
A contract used to insure the buyer of a bond against default by the bond issuer. This is what got Joseph Cassano and AIG Financial Products into so much trouble.
Derivatives
Contracts that obtain their value from that of a different commodity or product. (anything from wheat futures to Residential Mortgage Backed Securities). Derivatives were developed to help diminish risk but can also be traded for speculative purposes. In 2003 billionaire investor Warren Buffet called highly complex derivatives like Credit Default Swaps and Collaterized Debt Obligations, “financial weapons of mass destruction”.
Market Maker
A trader who commits to posting continuous buy and sell prices to help create a liquid market and facilitate deals. The market maker hopes to make a profit on the difference between prices and from fees charged.
NINJA Loans
Loans made to people with No Income, No Job or Assets.
PE Ratio (Price to Earning Ratio)
The ratio between the price of a stock and the yearly earnings it pays in dividends. It is a key number investors evaluate when deciding whether or not to purchase a stock.
Ponzi Scheme
Used to describe any scam that pays early investors profits from those who buy in later. The promise of high, instant returns attracts people, but the windfall is an illusion. When people cease to invest the scheme collapses. Named after swindler Charles Ponzi, who saw an early version of his scam in action while working Montreal’s Banco Zarossi around 1907.
Regulatory Arbitrage
Occurs when companies chose a place of business because of lower costs and more permissive regulatory, legal or tax regimes.
Residential Mortgage Backed Securities
Bonds in which mortgage repayments are channeled to investors rather than the mortgage issuer.
Securitization
The process of packaging debts (like supbrime mortgages) into new investments (like Residential Mortgage Backed Securities or Collaterized Debt Obligations).
“Securitization was the biggest U.S. export business of the 21st century. More than $27 trillion of these securities have been sold since 2001, according to the Securities Industry Financial Markets Association, an industry trade group. That's almost twice last year's U.S. gross domestic product of $13.8 trillion.” – Mark Pittman, Bloomberg News, 2008.
Subprime Mortgage
A home loan granted to a borrower with less-than-perfect credit. The interest rate charged is higher than that obtainable by those with a good credit rating. (See NINJA Loan)
Tranche
French for slice. Used in finance to denote a section of a Collaterized Debt Obligation (CDO). Some tranches are more risky and pay more. Others are relatively more conservative but pay less.
Yield
The annual income earned from an investment. Usually expressed as a percentage of the money invested.
