Mortgages, Securities, and Bailouts
In the past, as Gretchen Morgenson recently pointed out in The Times, the bank that made the loan would often have been willing to offer a workout, modifying the loan’s terms to make it affordable, because what the borrower was able to pay would be worth more to the bank than its incurring the costs of foreclosure and trying to resell the home. That would have been especially likely in the face of a depressed housing market.
Today, however, the mortgage broker who made the loan is usually, as Ms. Morgenson says, “the first link in a financial merry-go-round.” The mortgage was bundled with others and sold to investment banks…
My guess is that [the solution] would involve federal agencies buying mortgages — not the securities conjured up from these mortgages, but the original loans — at a steep discount, then renegotiating the terms. But I’m happy to listen to better ideas.
Based on my understanding of mortgage securities markets, I think there may be problems with this sort of idea. If you are a mortgage borrower and your loan is “securitized,” that means that it is pooled with a lot of other loans that are sold as a large security. Once a loan has been pooled, there is no simple way to un-pool it. If the a third party were to buy the individual loan at a discount, this would have to be treated as a mortgage prepayment within the pool. Prepayments advantage some investors and disadvantage others, so the companies that created the securities could face legal challenges from investors if they do something that alters prepayment patterns. One of the disadvantages of securitization (there are many advantages) is that the rules for servicing the loans cannot be changed after the fact.
What Krugman wants is for the borrowers to keep their houses and the financiers to lose money. I think you have to pick one or the other. Either subsidize the borrowers, so that they can stay in their houses, which bails out the financers; or let the foreclosure process play out, which will give the financiers the losses they deserve.