{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

The rationalization for the privatization approach is

Info iconThis preview shows pages 115–117. Sign up to view the full content.

View Full Document Right Arrow Icon
The rationalization for the privatization approach is that the banking sector is quite capable of doing mortgage lending to households, just as it is for providing lending to corporations and credit card lending to households. It is quite capable of pricing risky corporate loans and junk bonds, so why would it not be able to price and trade risky mortgage bonds (the junior tranches of the MBS)? The private market may currently well be crowded out of the mortgage lending market by the extensive activity of the GSEs. The advantage of this approach is that it would eliminate the distortions that arise because of government guarantees, such as artificially low financing costs enjoyed by GSEs (or their nationalized equivalents) and the resulting low mortgage rates. The pure privatization option, however, has several risks that would have to be managed carefully by the government or the mortgage market regulator. First, the government would have to make explicit that there will be no future bailouts of the new private mortgage players. The bankruptcy/receivership resolution mechanism for financial firms would also have to be applied to private mortgage securitizers. To make this credible, the regulator that oversees the secondary mortgage market should promote and enforce competition. The conforming mortgage lending business should become a competitive industry so that new too-big-to-fail institutions can be avoided. The problem, however, is that a fully privatized mortgage market does not exist in a vacuum. Financial firms do not operate in a free market. The banking system is heavily regulated with government guarantees for deposit institutions; large financial institutions issue systemically risky liabilities; contrary to the goals of the new Dodd-Frank Act, too-big-to-fail has not gone away; insurance companies receive state insurance guarantees; and so on. Furthermore, mortgage origination is heavily concentrated in the four largest banks today. It is highly likely that a privatized mortgage banking system would just morph into a group of privately run “GSEs” with effective government backing. In fact, Section 3.3’s “Race to the Bottom” scenario laid out how this occurred in the current crisis. Given the currently vague plans of the Dodd-Frank Act to contain systemic risk resulting from the wind-downs of large financial firms, it is not clear that a race to the bottom wouldn’t happen again. 54 Second, with respect to slicing and dicing the credit risks of MBS into tranches, there is a certain “déjà vu” feel to it. As the current crisis demonstrated, it is not just the credit risk of these securities that is relevant, but also their liquidity risk and model mis-specification risk. If these securities cannot be converted to cash during a crisis, then the viability of tranching as a
Background image of page 115

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
114 candidate to be the secondary market for mortgages needs to be questioned. As argued above, although it may be viable over the long-term, it most likely is not in the immediate future.
Background image of page 116
Image of page 117
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}