A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

by Burton G. Malkiel

the “originate and distribute” model of banking. Mortgage loans were still made by banks (as well as by big specialized mortgage companies). But the loans were held by the originating institution for only a few days, until they could be sold to an investment banker. The investment banker would then assemble packages of these mortgages and issue mortgage-backed securities—derivative bonds “securitized” by the underlying mortgages. These collateralized securities relied on the payments of interest and principal from the underlying mortgages to service the interest payment on the new mortgage-backed bonds that were issued. To make matters even more complicated, there was not just one bond issued against a package of mortgages. The mortgage-backed securities were sliced into different “tranches,” each tranche with different claim priority against payments from the underlying mortgages and each with a different bond rating. It was called “financial engineering.” Even if the underlying mortgage loans were of low quality, the bond-rating agencies were happy to bestow an AAA rating on the bond tranches with the first claims on the payments of interest and principal from the underlying mortgages.