Calamity Call

  

Also known as a cleanup call, calamity calls are included in securities backed by mortgage pools called collateralized mortgage obligation (CMO). The calamity call is designed to protect the investors in the event of, well, a calamity.

Investors buy into the CMO as a way to access the profit from mortgages (assuming the payments are made on time and in full) without having to write the mortgages themselves. If those payments stop or the mortgages are defaulted on, the investors not only lose out on any profits, they could lose what they initially invested. In this case, the issuer cancels a portion of the CMO.

This escape clause is sort of a defensive mechanism to protect investors. Adding things like the calamity clause to CMOs also provided a way to lure investors back in after the housing market collapse in 2008 (which led to a meltdown in the CMO market, and a near-meltdown of the economy generally). This protective feature reassures investors that if profits start to drop, and their investment is at risk, they'll be pulled out of it before the damage gets too bad.

Related or Semi-related Video

Finance: What is Collateralized Mortgage...65 Views

00:00

Finance a la shmoop what is a collateralized mortgage obligation or

00:07

CMO all right people well this is a GMO and this is a CMO yeah it's a bunch of

00:17

mortgages in one investment vehicle pot like mortgage Stone Soup not nearly as [Mortgage stones in a bowl of soup]

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exciting is that that man-eating plant over there

00:27

so yeah just a bunch of mortgages that are packaged together when banks and

00:30

investors package mortgages together well they can treat them like they're a

00:34

big fat indexed bond fund because these groups of mortgages while they pay

00:39

interest ie the interest comes from the people who are actually paying off their

00:43

mortgages so why would you collateralize a mortgage obligation anyway answer risk

00:49

by packaging lots and lots of mortgages together the theory was that well as a [CMO boxes on a conveyor belt]

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whole they would create a much less volatile environment than the former

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alternative of having tens of thousands of individual mortgages many of which at

01:02

any given time were you know in do rest as people were dead beating and not [Man playing video games]

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paying what they promised to pay back right well collateralizing this group

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meant simply placing all of them into one investment vehicle that could be

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bought and sold as if it were in ETF or individual closed end fund but Wall

01:20

Street being Wall Street where greed is good until it's not abused the notion of [Boxing gloves punch collateralized]

01:26

collateralized mortgages and actually applied the notion of collateral against

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them pledging as collateral the equity in these mortgages or packages of

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mortgages and then borrowing against them so it's like leverage on leverage,

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highly volatile and this is sort of like the brilliant idea of the fraternity [Man walking along]

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social chairman sending the pledges to get graham crackers marshmallows and

01:50

chocolate when he sees his you know couch is on fire yeah like why wouldn't [People carrying snacks and a couch on fire appears]

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he just put it out like what was he imbibing there all right well in fact

01:58

this is more or less what happened in the mortgage meltdown of 2008 and 9 and

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it was helium inside of the couch that exploded in the form of many of these [Helium explodes on a couch]

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mortgages becoming insolvent and as one mortgage went bad

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well it caused a chain reaction of panic up and down the economic food chain

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which resulted in the near bankruptcy of the United States financial system

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basically the people who pulled together these CMOS forgot what the O stands for [Man walking along the street and plant eats him]

02:27

oh dear, oh my

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