Equity slice
The "equity slice" was the riskiest part of the RMBS.
It was typically sold at a wide discount to the total value of the loans in this category, meaning that
if defaults were less than expected, the buyer of this part of the package could make a capital gain in addition to a very high yield.
Even if defaults were average, the buyer would still earn a nice yield.
Hedge funds loved this kind of security because the yield on it would cover the interest on the money the fund would borrow to buy it.
Hedge funds could make double-digit capital gains annually, cost-free and risk-free... or so they thought.
As long as home prices kept rising and interest rates kept falling, almost every RMBS was safe.
Even if a buyer got into trouble, he could still sell his home for more than he paid or find a way to restructure the debt.
On the way up, from 1995-2005, there were very few defaults.
Everyone made money, which attracted still more money into the market.
By Porter Stansberry
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