Reply #92: I think that was re: a couple credit card companies. [View All]

[Frodo]

Fannie Mae and Freddie Mac don't actually take in deposits and loan money out the way a bank does. They package groups of similar mortgages into bunches and sell them just like bonds/treasuries. They tend to act very similarly to a 10-yr treasury security in terms of payout over time (people don't usually hold 30yr mortgages for 30 years.)

Of course there is more risk associated with mortgage securites than treasuries (default risk of the underlying mortgages to the extent collateral value exceeds real market value at foreclosure - but that's why these loans are never for more than 80% of a home's value, it would take a massive crash to destroy more than 20% overall), so they pay a higher return.

A couple credit card companies have started to do the same thing. They are no longer "banks" in the sense that they loan out deposits. They "securitize" bundles of credit card assets into something very like a bond. They essentially borrow the money to loan out to the credit card customers. Some people find this attractive because of the much higher rates they pay, but (as I suspect you would guess), the default rate on credit cards is MUCH higher and MUCH more variable... so these securities are much riskier. There is some measure of protection in that the rates are also much higher and they can absorb a pretty hefty loss ratio and still pay out the expected income.

It effectively shoves part of the risk involved in credit card lending out to the investors (while giving income investors another -higher paying - option) and takes it off the back of the "bank".

The practice is not acceptable in my mind. But I don't get to make the rules.