Profiting from subprime turmoil

Here's a great article by Micheal Sivy over at CNNMoney that so far for me, explains the subprime debacle at it's "best" and simplest. It's not as long a read as you thnk, and the insight is quite sublime.

From the article:

"News this week that major banks are planning a massive fund to prop up the hardest-hit victims of the subprime mortgage crisis got investors worrying again. Specifically, they're concerned that potential losses from bad subprime bets could be much bigger than previously feared.

In fact, the bailout fund is good news. And you actually have a chance to profit personally over the long term from today's turmoil, as long as you make your investment decisions cautiously.
Shares of banks and financial services companies may not have hit bottom yet - but there will soon be bargains to be had. And some companies with exceptionally strong balance sheets are already good deals.

Understanding the problems

The credit crisis itself is very complicated, but here's pretty much what you need to know. As home prices kept rising over the past few years, more and more people wanted to buy houses. Lenders accommodated them by devising mortgages that required less money down and lower monthly payments.

Often the interest rates on these mortgages could increase sharply from initial low levels. That created the risk that buyers who had stretched to the utmost to buy a house could be forced to default.

The risks were greatly multiplied as the original mortgages were bundled into separate investments and sold off. This kind of packaging has been done for decades by institutions, and the resulting securities have long been part of a stable credit market.

But the new packages, a type of collateralized debt obligation (CDO) known as structured-investment vehicles (SIVs) are far more complicated - too complicated, in fact. The packagers sliced and diced underlying pools of mortgages, mixing lousy loans with solid ones, until nobody could tell what was what. Even the resulting investments that had great credit ratings could ultimately be backed in part by shaky mortgages.

In addition, long-term assets in the portfolios were financed with short-term borrowed money. That means that rising interest rates or tight credit could force banks to take losses as they scrambled for cash.

The great risk is that the overall credit market freezes because lenders are afraid to lend."
CNNMoney

There's more to this article, but I wouldn't do it justice by editorializing on it. Do yourself a favor...read. ;-)