The Big Short" Explained Part1

Listen, open the darn Fed window. He has no idea how bad it is out there, he has no idea! He has no idea! -Cramer... I have talked to the heads of almost every single one of these firms in the last 72 hours and he has no idea what it's like out there, none!
And Bill Poole has no idea what it's like out there! My people have been in this game for 25 years! And they are losing their jobs and these firms are gonna go out of business And he's nuts, they're nuts! They know nothing!
You may be old enough to remember exactly how bad fiscal year 2008 was for America. If so, you were probably one of eight million people that lost their jobs as a result. But if you're like me and you were too young at the time to understand what was going on, allow me to explain exactly what happened and why.
A little finance 101 to get us started. When an organization needs to raise money, one of the ways it does so is by issuing bonds to investors. Bonds are a lot like their title infers, they are a contract to pay a lump sum at a predetermined date, along with any and all recurring interest or coupon payments over the life of the bond. Unlike stocks, the value of your bond does not decrease based on the value of the company.
The bond is exactly that - a bond between two parties. Because of this, bonds are generally seen as safer investments. So in the late nineteen seventies, Lewis Ranieri came up with the idea of a mortgage-backed security. But what is a mortgage-backed security? Well, let's dissect this quick. So the bank issues mortgages but these mortgages have a perceived risk of the customers defaulting on the payments.
The bank doesn't want to take on the risk involved in these mortgages, so it gathers up hundreds of mortgages and sells them to a trenche. A tranche is essentially a pool of like-investments. So this tranche takes in all of these mortgage loan payments and is in business. The tranche in turn issues bonds leveraged against the income provided by the mortgage payments.
So you and I and even the banks can buy these bonds that are sold by the trenche. In fact, a lot of pensions bought into these bonds because they have a high return with relatively low risk because it's.. a mortgage.. who the hell doesn't pay their mortgage? However, the banks doubled down on these bonds because they received a commission for not only selling the mortgages to the trances, but they also received the benefit of buying the bonds leveraged off of these same mortgages. The banks won big time and took on none of the risk because if some of the mortgages didn't get paid - the bond still got paid. But if the bond still gets paid, how did these mortgage-backed securities cause the economy to go into a deep recession?
Well, because the company can go out of business and default on its creditors, there is some risk involved. To measure the degree of risk involved in the purchase of a certain bond, there are rating agencies such as the Standard and Poor's and Moody's. Each of these agencies rate the amount of risk involved in each investment based on an alphabetical system, where a AAA-rated bond is a significantly safer investment than a C-rated bond - which is commonly known as a junk bond.
So, because these huge banks were incentivized issue more mortgages to in turn sell to trenches and buy securities off of, they started unscrupulously issuing more mortgages - mortgages that were issued in great numbers to people with shitty to no credit scores. Mortgages that were unlikely to be paid. At this point, anyone could get a mortgage. Even the high school dropout living off of welfare.