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Comment by KaiserPro | Hacker News Reader

There is nothing inherently wrong with mortgage bonds.

The principle is simple and fine, chop up a bunch of mortgages from all over, with the same risk profile and pool them together.

That way local environmental factors don't cause the whole investment to go south. Basically raid for investment

What is a problem, and one that still hasn't fully been tackled is the industrial scale fraud that sold delinquent, or knowingly under par mortgages as high quality instruments.

Through all the use of fancy words, every seems to have got the impression that commoditized mortgages investments are complex, using words like "tranche", "proprietary instruments" and blended risk.

its really not, get a bunch of mortgages, shove them in a blender and make mortgage sausage.

So long as there isn't widespread and systematic fraud, then everything will be fine.

However considering that there haven't been large scale arrests, I don't hold out much hope.

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> There is nothing inherently wrong with mortgage bonds.

If Bank X is sloppy about qualifying customers for mortgages but keeps the mortgages on their own books, the sloppy behaviour will bite them in the ass. Thus, they are incentivised to be careful with no external oversight needed.

The moment it's possible to sell the mortgages on, that incentive is removed.

> The moment it's possible to sell the mortgages on, that incentive is removed.

It's not. Investors in the secondary market don't want to buy shitty subprime loans. The only reason lenders originate these awful loans is because the government incentivizes them to do so by guaranteeing to buy them via Fannie and Freddie. Fannie and Freddie buy half of all US mortgages, and in doing so dramatically distort interest rates and the amount of liquidity in the housing market. They also guarantee these loans, something a lender would never do, which is why mortgage-backed securities were considered "safe" leading up to the crash in 2008.

If Fannie and Freddie didn't exist, subprime loans would either not exist or would have dramatically higher interest rates in order to properly protect against the risk of default.

Fannie and Freddie do not buy subprime loans, subprime stays in the private market. If Fannie and Freddie didn't exist, prime rates would be closer to subprime rates since it's effectively those prime rates that are being subsidized.

> Fannie and Freddie do not buy subprime loans, subprime stays in the private market.

I'm not sure where you got that idea. Fannie and Freddie exist for the explicit purpose of making mortgages more accessible to people who would otherwise be considered too risky to lend to (low down payments, low income, no assets, etc.). They do this by purchasing mortgages that are underwritten to lower standards and at lower interest rates than would be acceptable to private lenders, effectively shifting the risk from private lenders to the taxpayers.

Fannie and Freddie bought a tremendous amount of subprime loans. From page 454 of the Financial Crisis Inquiry Commission report[1]:

> "...on June 30, 2008, immediately prior to the onset of the financial crisis, [Fannie and Freddie] held or had guaranteed 12 million subprime and Alt-A loans. This was 37 percent of their total mortgage exposure of 32 million loans, which in turn was approximately 58 percent of the 55 million mortgages outstanding in the U.S. on that date. Fannie and Freddie, accordingly, were by far the dominant players in the U.S. mortgage market before the financial crisis and their underwriting standards largely set the standards for the rest of the mortgage financing industry."

[1] https://fcic-static.law.stanford.edu/cdn_media/fcic-reports/...

What I meant to say is, Fannie and Freddie no longer purchase subprime mortgages (not since the crisis). You’re citing numbers from 11 years ago, and the structure of the market has changed considerably since then. Subprime specifically refers to low credit scores (below 620), which is purely in the private market now since Fannie and Freddie no longer buy those.

Whether or not you agree with the risk assessment of lending to low income borrowers, it is strictly not the same thing as subprime lending.

nobody wants to buy subprime debt.

the reason why people did was because the instruments they were buying had a fraudulent A rating slapped on them.

As soon as word got out that these thing were dodgy, they were junked. Or sold on to some sucker and then junked.

the regulated market only work if illegality is minimised.

The skepticism with respect to ratings is likely forever damaged, since everyone knows bankers aren't held liable for their actions. On paper, Dodd Frank may have changed, but if bankers hand out rosy, inaccurate ratings -- we know there will be no liability. There is no reason to trust ratings. But accurate ratings are an essential part of the financial system.

Right, this time around people will be careful to keep these bonds off their book but still get a commission for selling them

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