paper about MBS

78 137 of course critics will argue that without the

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Unformatted text preview: 78 137 Of course, critics will argue that, without the support of the GSEs, the cost of obtaining mortgages will be that much higher, effectively shutting out a large number of potential home- buyers, and the liquidity of the secondary mortgage market will be significantly impaired. In fact, in an interview with the Financial Times that appeared on August 12, 2010, legendary bond investor Bill Gross of Pimco stated: “Without a government guarantee, as a private investor, I’d require borrowers to put at least 30 per cent down, and most first-time homebuyers can’t afford that.” But if mortgage lenders and securitizers cannot issue and securitize mortgages without full government backing, then this says more about the current business model of mortgage securitization than anything else. If we really think that the only source of capital is the government, we will have implicitly socialized the mortgage financial system. It is certainly true that the vast expansion of mortgage finance could not have taken place without the involvement of the GSEs. But why was this expansion necessarily a good thing? The current administration is desperately trying to keep the housing market afloat even though all economic signs point in the opposite direction. Of course, the tale of this financial crisis is that homeowners, mortgage lenders, securitizers, and investors in mortgage-backed securities all took advantage of the freebies thrown at them either directly or indirectly by the GSEs, and are now drowning in debt and crying foul that the gravy train is over. Of course, the creative destructive nature of capitalism can solve this problem. Once creditors of mortgage lenders get hit and investors in mortgage-backed securities lose, market discipline will come back to the mortgage finance sector. Mortgage lenders will change their behavior and focus on borrower quality, and investors will audit these lenders and once again measure and price aggregate credit risk. As in other parts of the world, lower loan-to-value ratios (i.e., larger down payments) and stronger recourse for lenders will reduce the amount of mortgage default risk in the economy; and borrowers will choose adjustable-rate mortgages if the cost of fixed-rate mortgages becomes too high. All of this will lead to a private and more efficient level of risk-sharing in the mortgage finance market. The reform of mortgage finance will end up being mostly organic and not require the heavy hand of government. Nevertheless, there still might exist the market failure of systemic risk to the extent that individual financial firms do not bear all of the costs of lending, guaranteeing, or investing in the 138 systemically risky housing market. Having the government provide capital side-by-side with firms that offer mortgage guarantees and yet getting compensated based on the private price of guarantees is one pragmatic compromise to address this issue. But limited government involvement of even this sort must be tightly ring-fenced to the relatively high quality...
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78 137 Of course critics will argue that without the...

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