Risk and Mortgage Backed Securities in a Time of Transition

Abstract

The residential mortgage backed securities (MBS) market expanded and collapsed as securitizers packaged increasingly toxic loans into private label MBS. Underwriting of the ability to repay was replaced with new affordability products and expectation of continuously rising home prices. The risk of default was misrepresented by securitizers and credit rating agencies. As a result of the financial crisis of 2007-2008, 90 percent of loan originations are now insured or guaranteed by taxpayers. Public and private investors are seeking compensation through litigation. The Dodd-Frank Act has produced a rigorous ability to repay qualifying standard as well as liability for non-compliance. A lender “skin in the game” or borrower down payment requirement might also be forthcoming. The new rules could substantially reduce the risk of default while excluding many borrowers and first-time homeowners from the mortgage market. An inclusive private label MBS market has not yet emerged.

Keywords: Mortgage backed securities, subprime mortgage, Goldman Sachs, credit rating agencies, financial crisis, Dodd-Frank, qualified mortgage.