I will stipulate that we all are aware of the issues brought to light regarding the now-known-as “Toxic” Subprime Loans. Home Equity loan foreclosure also was a part of the deal. But what you probably don’t know is that if AIG, the world’s largest insurance company, hadn’t gotten involved in the ‘shady’ way it did, this mortgage crisis could not have escalated to this degree.

Things were slowly headed downhill due to fraudulent lending practices in the subprime market, but this catastrophic explosion that we are all wounded by would not have happened without AIG’s ‘Contract” hits on The American Dream.

Allow me to oversimplify the process. Banks are regulated and some of those regulations are based on ‘quality’ (i.e. AAA rating). The more risk the home loan carries the more money the bank must keep in reserve. The more money the bank must keep in reserve the less money the bank has available to lend on home loans and home equity loans. The less money the bank lends the fewer profits the bank generates.

These subprime ‘low quality’ risky home loans yielded very high interest which made them very tempting to a large foreign bank that had volumes of deposits just sitting around not earning their keep. But alas the higher the risk the higher the banks reserve and the fewer dollars the bank had available to lend out. The problem was the old pesky regulation that would force the bank to keep higher reserved on hand because of the risk.

It seems that AIG gave banks a way to circumvent (fancy word for loophole) the above regulation (Basel II rules). AIG would right unregulated insurance Contracts, also known as Credit Default Swaps (CDS). A CDS is insurance on bonds. And why not, they could make a fortune selling CDSs just on the premiums alone and the chances of them ever having to pay out were slim to none. Are you starting to smell the stench of the combination of home loan with foreclosure? Of course you are.

So here we go:

Number 1) The banks wanted the highest interest possible, the highest ratings possible, and low reserve requirements leaving them lots of money to lend to maximize their profits. Banks discovered that it was much easier to buy and sell CDS contracts than actual bonds. Number 2) AIG (along with other insurance companies) invested in mortgage-related securities primarily for the interest. No wonder the foreclosure of home loans pursued.

So the AIG Brokers sold CDSs (insurance contracts) to the banks on subprime securities. With their AAA rating, AIG was not required to put any collateral into play on the CDSs. If red flags haven’t gone up yet in your mind, let me help you out … no collateral and no regulation and no limit on how many of these subprime CDSs you can transact! And you wonder why you have a home loan with a foreclosure looming. Ever wonder what happens to a home loan after a foreclosure?

On multi-year credit default swaps, the accountants at AIG would right down in their books what dollar amount of profit they were expecting on each CDS. All parties to the transaction are happy and have been paid. But wait a minute we are talking about the first month of the first year of a three or five year insurance contract. The actual profit has not been realized! Is that considered to be fraud?!

As we all now know, those AIG profits were never realized and AIG had no capital as collateral backing up the insurance that it was selling. The losses started materializing so AIG was finally downgraded from its AAA rating and now needed to produce billions that it didn’t have.

The market for credit default swaps collapsed which caused a liquidity crisis for the banks. Sure there were other factors that led to us being in this financial disaster, but if only AIG had collateralized those credit default swaps this thing would not have blown up in all of our faces.

Now banks are not lending to Mr. and Mrs. Homeowner or other banks. Home Loans, foreclosures … they now go hand in hand! When AIG wrote the ‘contract’ they put a hit out on The American Dream.

Biography: Monica McKinney is a Mortgage Loan Strategist, licensed and certified in Real Estate and Mortgage Loan Brokering. Monica is also an Award Winning Writer and has just authored an exciting new mortgage approval guide, “Mortgage Approved!: Your Easy All-In-One Home Loan Kit, The ONLY Mortgage Approval Guide You’ll EVER Need”. This great approval guide book is filled with insider secrets, mortgage loan help and mortgage loan tools. Get more mortgage information from Monica. Click: Get Informed…Get A Mortgage