The Anatomy of the Mortgage Securitization Crisis
Abstract (Via Ualberta)
The current crisis in the mortgage securitization industry highlights significant failures in our models of how markets work and our political will, organizational capability, and ideological desire to intervene in markets. This paper shows that one of the main sources of failure has been the lack of a coherent understanding of how these markets came into existence, how tactics and strategies of the principal firms in these markets have evolved over time, and how we ended up with the economic collapse of the main firms. It seeks to provide some insight into these processes by compiling both historical and quantitative data on the emergence and spread of these tactics across the largest investment banks and their principal competitors from the mortgage origination industry. It ends by offering some policy proscriptions based on the analysis.
Excerpted Introduction (Via Ualberta)
The market to sell home mortgages as “securities”, what are called mortgage backed securities (hereafter MBS) is at the core of the current financial crisis. The crisis, which is still ongoing, has been evolving too quickly and on too many fronts for anyone, especially scholars, to successfully unravel it. It is clear that the financial community, the policy analyst community, and government officials mostly underestimated what was happening and optimistically thought at many points that the crisis could be contained. The crisis in the mortgage securitization market came as a great surprise to the people who ran the companies that produced the meltdown. The president of Bear Stearns, James Cayne, for example, has argued that the company did nothing wrong and did not take risks they did not understand even as his company was headed towards bankruptcy (Cohan, 2009).
There are already a set of conventional wisdoms that have taken hold. So, for example, one of the “facts” that is already taken for granted in the analysis of the meltdown is that the banks that originated mortgages and packaged mortgage securitization never held onto the securities themselves. It is asserted that this perverse incentive made them more likely to take on larger risks. We show that contrary to this view, every large originator and packager of mortgages held onto substantial numbers of mortgage backed securities. They believed that they could control the amount of risk they held. The result is that most of these firms are either out of business, merged into larger banks, or owned by of the federal government.