Securitized mortgages became the ¨toxic assets¨of the “Great Recession.” They were and are still being blamed for the financial mess that led to the “Great Financial Meltdown of 2008″ and the ¨Great Recession of 2009.” Now I will agree that these complex investments were at the heart of the “meltdown,” but I have written several blogs stating the the problem was not the mortgages themselves, but the lack of understanding of the size and nature of the market, due to a lack of transparency in their trade. The most ridiculous exercise was the demand “to mark these investments to the market” when no such market existed.
We can continue to debate how well this investment instrument worked in practice, but its concept and original goals were sound. By securitizing mortgages a whole host of investors were drawn to the mortgage market, thus producing funds to lend far beyond what was present before. No longer were mortgages the sole purview of good ol´Johnnie Brown at the local bank, they became the darling of the most powerful investors on the planet. And this huge increase fueled a housing boom.
Another benefit of securitized mortgages is that this allowed the risk to be spread around so that a loss would have less impact on an individual investor than if he were to hold the entire mortgage himself. Still another advantage was that it made mortgages more competitively priced since the offer was so large and relatively safe.
We all know what happened to tarnish this glow. The housing market reached a saturation point, not because no more buyers were looking for their dream home, but because those who bought with an intention to rent out the property saw the rental market dry up or become too much of a loss (in personal financial planning one does need some losses to reduce taxes, but not excessive loss). Doubt this is the reality, ask any of your friends it they have their “dream” home, maybe 10% will say yes.
Since the securitized mortgage market was not transparent, i.e. one could not readily find the facts and figures behind the investment instrument, we did not even know how large the market had become, those who analyzed the market used surrogates called algorithms to determine the value of the securities. Unfortunately these were based on the housing market, not the mortgage market or the performance of the securitized mortgage securities. The algorithms predicted large foreclosures due to stagnant, or falling, home prices. So the securities were marked, not to the market, but to abstract ideas about what led to foreclosures.
We heard many call the securitized mortgages bad because they used adjustable interest rates or were “sub-prime” loans, i.e. loans that carry an interest higher than the best rate offered by the lender. Well the adjustable rates were adjusted, down, not up, so this caused no distress for mortgage holders. And contrary to popular belief, sub-prime loans were created to provide mortgages for investors, not home owners per se. The reason, prime rates are only offered to those who will live in the home, i.e. homeowners, thus any mortgage given to an investor was “sub-prime” and at a higher rate of interest. I know, I secured precisely this type of loan for all my buyers since they were foreigners buying second, third, fourth or more homes as investments.
As we later found the fear of foreclosures due to adjustable rate mortgages or sub-prime loans did not come true. The national rate of foreclosures for 2006 was the same as for 2007 and 2008 when they were supposed to sky rocket. The fear and panic induced by the faulty values given these investments by analysts using faulty algorithms did, however, lead to the recession that caused the loss of some 8 million jobs in 2009. Not surprising, the foreclosure rate in 2009 did double from the 2% of the cited years to 4%.
So it was the faulty analysis due to the lack of transparency in the securitized mortgage market that caused economic chaos and the resulting lousy economy.
Now how do we get out of the doldrums? Well, we recreate that huge offer of home loans based on securitized mortgages, only this time the market will be subjected to the transparency that lies at the heart of the Dodd-Frank Act and thus not be subject to the whims of analysts using faulty algorithms.