paper about MBS

Corrects any market failures if they exist notable in

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Unformatted text preview: corrects any market failures if they exist; notable in this case is the externality from undertaking too much credit and interest rate risk as this risk is inherently systemic in nature; (iii) maintains a level-playing field between the different financial players in the mortgage market to limit a concentrated build-up of systemic risk; and, (iv) features market pricing of risks as well as charging for implicit or explicit government guarantees. Based on Chapters 1-5 of this book, there should be little doubt that the current mortgage finance system falls far short of these goals. In particular, moral hazard is rampant as financial institutions – the GSEs, other large and complex financial firms, and FDIC deposit institutions- load up on mortgage risk knowing that they are insulated from its full consequences. Indeed, economists Nadezhda Malysheva and John Walter at the Federal Reserve Bank of Richmond find that 58% of all liabilities of the financial sector now come under a safety net. Because this safety net either is not priced or is underpriced, large distortions occur, such as subsidized financing of financial firms and the loss of market discipline. Somewhat perversely, the problem is all the more worsened by the financial firms’ becoming systemically important and thus too- big-to-fail: The implicit government guarantee gets more ingrained, and the negative impact is that much more. And rather than the regulatory system’s discouraging this behavior, it is actually encouraged. The combination of GSEs and commercial banks or thrifts in a securitized mortgage finance system has less than 30% of the capital requirements of traditional banking. No wonder we are where we are. It should be clear then that mortgage markets operate in the broader context of the financial system and its existing infrastructure and regulation. The Dodd-Frank Act of 2010 is likely to affect this broader context in non-trivial ways by regulating origination, securitization, 103 and rating aspects of mortgage finance. Given the undesirable state of mortgage finance in the U.S. at the present moment, transition issues must be addressed on the road towards the desired long-term reform. How much – and in what form – should government involvement persist in the long- term reform of mortgage finance? As a fundamental principle, government involvement should only be present to the extent that it improves the efficiency of the reformed housing finance system, as outlined above. This is the best way to minimize costs to taxpayers, in sharp contrast with the seemingly endless losses that we witnessed with Fannie and Freddie. Such an efficient system can restore liquidity in the moribund markets for mortgage-backed securities (MBS), facilitate efficient risk-sharing across different institutions and households, and support a wider availability of fairly-priced mortgages....
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