Counter Economics

Something very instructive is how mortgages evolved over time. In the past banks and savings and loans owned and serviced mortgages in the US. After the savings and loan crisis of the 1980’s this dramatically reduced the number of savings and loans, which was really too bad because there is good evidence that savings and loans offered better values to borrowers than banks.

Mortgage Selling

In the 1990’s something strange happened, banks were not happy with doing loan origination or loan ownership and decided to give away a lot of the origination business to mortgage brokers and then selling the mortgages to Wall Street. Of course Wall Street did not want to hold the mortgages either, but instead wanted to pretend they were better quality then they were and pass the hot potato to someone else. However, the buyer of the debt obligation got further and further away from the the loan origination, and the information got worse and worse. Likely there was a high degree of lying as the mortgage moved from origination to its final resting place in a pension fund. The chain of lying would look like this:

1. Mortgage brokers filled out paperwork in a way that overestimated the buyers ability to pay off the loan
2. The bank then makes the mortgage quality seem better than it is to Wall Street
3. Wall Street than makes the mortgage quality seem better that it is to an institutional investor, in addition to paying off a rating agency to give the mortgage(s) a high rating
4. The institutional investor ends up owning mortgages that have been overestimated three times at least

The accounting was so problematic on these mortgages that many of the lowest quality mortgages or the “C” category of the repackaged mortgages sent into accounts in overseas private banking accounts so no one would see them.

Michael Hudson explains…

“Being implicitly government-guaranteed, Fannie Mae and Freddie Mac were able to borrow at fairly low interest rates, and sell mortgages at a premium. Demand for these packaged mortgage securities provided an enormous new source of lending. It also turned banks into mortgage originators rather than mortgage holders.”


Reference

http://www.michael-hudson.com/articles/debt/080411RescueGamblers.html