I’ve been unable over the past few months to satisfy my own questions about the impact of widespread foreclosure on the MBS market. Who holds MBS? Your mom’s pension fund, your own pension fund, foreign central banks, GSEs, everyone…. I bet even your money market account holds Fannie Mae short term debt, which holds MBS. This is a global holding. The problem is that the global liquidity was so huge, that investors did NOT demand the necessary risk premium for these loans.
The proper interest rate an investor should require on an ARM is not 1% over prime, but 3% over prime, and 5% over prime for a subprime borrower. I’m making up numbers, but you get the point… The investor was not compensated for taking on the risk of I/O, 100% financing, subprime, or any of the other risk layers.
Derivates, CMO (collateralized mortgage obligations), MBS, GSEs, all this is going to be a huge mess, and according to the Fed research papers, can cause a systemic financial crisis.
For more on this, read my post Sell Now, from last spring, which is a summary of John Talbott’s book. He delves into the impact of a financial meltdown of the GSEs and a recession, brought on by the housing bubble.
But this whole MBS problem is a little discussed problem. It is just like $100 oil. The people in charge of buying and drilling oil have known for decades that we are at peak supply, and demand is rising and won’t drop, yet they didn’t warn anyone or do anything about it. Same for the tech stock bubble, the housing bubble. Government, Wall Street, and the media have failed us time and time again. Our only real source of information is blogs, because we can share what is really going on, not what the government data is trying to tell us.
Good questions. If you get the answers, please come back and share. And search the archives, because I made some really good threads about Fannie Mae failures and MBS in the spring.