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Passing the Trash

You are buying barrels of apples.  In each barrel are a certain number of bad apples that should be removed by the seller before delivery.  Would you agree to a deal in which only 2.5% of the apples per barrel were removed, regardless of the true number of bad apples?

According to a recent report, some investment banks agreed to reject only 2.5% of the loans one of the biggest subprime lenders sent the banks to package and sell to investors.

A quality control auditor who reviewed subprime loans says that 75% of the time "kicks" or kick-outs (loans so risky that they should have been rejected) ended up back in the investment pool and were sold.  "Passing the trash," as this is known, allowed the investment banks to make as much as a 40% return on equity every two months by peddling the resulting securitizations.


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