Mark,
As far as I know, banks have just about always had the ability to sell their loan paper. That's basically what Fannie Mae was set up to do in the 30s.
According to news reports, Fannie and Freddie hold about half of the $12 trillion in US mortgages. I assume that would mean the other half is held by banks and/or investors in mortgage backed securities.
My understanding is the same as yours, that pools of mortgages had different ratings depending on the quality of the loans.
Unless I'm misunderstanding the term "securitization", I don't think that was the problem. The securities were just pools of the actual loans and were backed by the real estate the loans were made on. For example, if you sold me a home on an owner contract, you could sell the contract to someone else, pocket the cash, and they'd then be able to collect the interest and principal on the loan. The price they'd pay you for the contract would depend on the interest rate, my credit rating and payment history, and the face value of the contract balance compared to the current market value of the home.
The loan pools sold as mortgage backed securities were the same thing, only on a large scale. If the individual loans the pools were made of were good quality, there shouldn't have been any problem. The problem came from lending policies that made the individual loans excessively risky.
The face value of the loans was higher than the liquidation value of the assets that backed the loan to start with, and then the market value of the assets dropped another 20%.
So, instead of $12 trillion in loans on real estate that could be liquidated for $12 trillion, they started out with $12 trillion in loans on real estate that could be liquidated for $10-11 trillion. With a 20% drop in real estate values, they now have $12 trillion in loans on real estate worth $8-9 trillion. On top of everything else, that value is likely to drop further as more foreclosed homes go on the market to raise cash, and every 10% drop is another trillion dollars in losses the banks think taxpayers should cover.
To add injury to injury, we're almost certainly looking at an instant replay of the 80s where taxpayers take the hit on losses, then get hit again when the assets are sold back to the bankers at firesale prices.
The Fannie and Freddie bailouts included a provision to make loans at 15% above fair market value - if you can believe it. That means the next time the rubber meets the road, taxpayers will have to fork over the losses on loans where bankers have spent years paying people to buy houses.
The only appropriate solution in this kind of situation is to let the investors and lenders take the losses they so rightfully deserve. Then, and only then, should the government step in to add liquidity to the market. Just about any solution makes sense except the ones that revolve around covering investment losses.
For example, let the government buy up pools of foreclosed homes, instead of the paper on them. Hold them for 5 years as rental property to keep from flooding the market. As market conditions permit, sell them to individual buyers at fair market value, on contract terms that ensure the value of the loans are recoverable. Every bank in the country could go broke and the only persons harmed would be those that caused the problems in the first place. |
