How Wall Street Manufactures Financial Services Products

By Shah Gilani
Contributing Editor
Money Morning/The Money Map Report

Wall Street bankers create products like any other manufacturer seeking to sell goods or services for a profit.

The products those bankers create are financial instruments and the services they sell include advisory services, which they provide to investors and use to sell their financial products. And being the shrewd businessmen and women they are, Wall Street's bankers also make a habit of being both buyers and sellers of their own products. All the better to serve their customers who wish to trade their products.

The uniqueness of Wall Street's products is that simply by buying any of their products, purchasers own an opportunity to make money. If bankers can manufacture products that have greater moneymaking potential, it stands to reason that they can sell them for a greater profit. And like in any other business, the more products and services bankers sell with higher profit margins, the more they make.

The ingenuity of Wall Street is on full display when it comes to packaging products that incorporate mortgages. Banks assemble large numbers of individual mortgages into pools and sell pieces of those pools as securities.

The buyer of one of these securities owns a piece of the cash flow that comes into the pool every month when the actual mortgage holders send in their monthly payments. In order to manufacture higher-margin mortgage-related products, bankers amassed pools of subprime mortgages, where the underlying mortgages were debts of less than high quality but where the borrowers were willing to pay higher interest to qualify for that mortgage.

The underlying higher-interest-rate mortgages in the new pools meant that the subprime-mortgage-backed securities would pay investors a greater return, so Wall Street charged more for these products. And, in an effort to further boost the yields on these subprime-mortgage-backed securities, bankers "structured" pools into "collateralized mortgage obligations."

Structuring is a method by which the cash flow from a particular pool of mortgages does not simply "pass through" to the investors, but is actually re-routed to different investors who pay a higher price for a preferred directed cash flow. Again, the ingenuity of these products is that they offer different potential earnings opportunities for the purchasers, and have higher profit margins for the bankers who manufacture, sell and trade them.

About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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