Really, really wrong.
Dems, pundits and Kossacks especially are falling victim to a very Luddite and frankly uninformed way of thinking about the present crisis in sub-prime mortgages. There's a lot of "once upon a time, a mortgage was...." and it's just not even worth discussing. The mortgage market - indeed the entire debt market - changed permanently decades ago and it's nothing but good.
So long as people apply the very, very, simple rules that everyone knows are needed in a new market.
In the press, we are led to believe that suddenly - maybe a couple years ago - your local bank stopped holding your mortgage itself and started selling it to other banks who created securities with it. This is completely untrue. It's been happening for decades. In fact, it's such a common practice that there is a greater market for American mortgage-backed securities than there is for American Treasury bonds. That happened in about 2002.
And this is a good thing - a very, very good thing. Like it's so good that if it stops we are not just in trouble, but dead. Dead. No, seriously, dead. To go back to a system where a local bank holds an entire mortgage would mean financial suicide for America and even much of the world.
Seriously, you don't even want to think about what would happen.
A local bank will not and never does hold the whole loan for a middle-class person's house. Fannie Mae, Ginnie Mae, FHA and the various other governmental and quasi-public institutions who back up the American mortgage system take the lion's share of the risk. Always. You wouldn't be able to buy your house if you were just dealing with the bank.
Loaning to a working person rather than a rich person is profitable, because you charge the working person more interest. But it's much, much higher risk. So to do the loan, you have to share that risk, either with the aforementioned institutions and/or with other banks and/or...ideally...with even more investors.
And another thing!
Banks can only lend a slightly smaller amount of money than they have in deposits. But if they can sell a loan, they get the money back, collect fees for processing the payments and then they can lend that money out all over again. And that creates more cash in the economy and that makes everyone really happy. So banks had to figured out how to package and sell their loans. How to do it?
They realized that while the behavior of individuals is hard to predict, the behavior of very large groups of people is quite predictable. That's why insurance is profitable. So, they created enormously diversified packages of loans and demonstrated that, because there were so many loans to so many people, the risk and return were predictable. And so the mortgage-backed security (MBS) was born. And the MBS is just one of many types of asset-backed securites that make the financial system tick. It's not just a good idea or even a great idea, it is simply a vital component to the world economy.
Problem is, there are no formal standards for these securities. It's a "buyer beware" system. That's okay when a market is small and traders are all sophisticated - examining each new security carefully. But these securities were traded as if they were just as safe and predictable as bonds. They lacked regulation and transparency. Not only that, nobody really knew how many were being sold. Financial trading exchanges like the NYSE or the Chicago Board Of Trade scrupulously keep track of the inventory of what is being traded so that there are no (well, few) shenanigans. The exchanges can also force traders to "mark to market" - meaning they can make them admit what their profits and losses are - so you know that the trader on the other end of the phone isn't already bankrupt when she's making the trade.
Everyone - but everyone - knows that when a market gets large you must have these controls. Always. Always. Since the 1700's. And yet the people who create new markets also ALWAYS claim "oh, but WE are different."
Yeah, not so much.
Bush, being from Enronville (where people tried to create an energy exchange without proper regulation or rules and it predictably collapsed) was not the person to make MBS traders come to their senses. After the Dems win in 2008, they are going to have to re-create trust in the worldwide asset-backed securities market. It will be a huge task and a great opportunity.
Update [2007-9-1 15:44:34 by dlawbailey]: If I seem a little too calm about this, take a look at him: