Multiple Personality Nondisorder in the Mortgage Market

-- By TrevorGopnik - 06 Apr 2016

“It’s become a freelance business, in essence—that’s what it is.”

The U.S. housing market suffers from multiple personality nondisorder. The 2008 housing crisis, largely caused by the proliferation of mortgage backed securities (MBS), exposed the existence and inherent clashes between several of these personalities. MBS were created, as many alternate personalities are, as a response to a major trauma: The Great Depression. The U.S. government created these assets through a government-sponsored entity (GSE) known as Fannie Mae. By buying loans from loan originators, Fannie Mae was able to stimulate the market for mortgages by increasing the overall liquidity and size of the lending market. A larger mortgage market was beneficial for many of the economy’s different personalities: buyers had more money available to buy new homes, lenders could sell their newly created loans to GSE, and investors could buy the new GSE created MBS. Because GSE retained some the risk underlying the loans the bundled, only low-risk, fixed-rate loans where the homebuyers were unlikely to default or foreclose were purchased to form these assets which meant GSE, buyers, and loan originators could all coexist with a united interest in producing as many responsible loans as possible. In the 70’s, the united interest and coexistence of these multiple personalities began to disintegrate when private entities began selling their own MBS. These private MBS creators lacked the regulation of the GSE and created their assets without the mandated risk retention of the GSE. This created a situation where the interests of the buyers, a large home lending market seeking to make quality, low-risk loans, became decoupled from the desires of loan originators, investors, and the financial sector, to create, bundle, and sell the highest quantity of loans regardless of quality. Because private MBS creators were willing to buy subprime mortgages, a category of loan GSE wouldn’t touch, loan originators were willing to make more subprime mortgages with the knowledge that the risk would soon be sold to a private MBS creator and then passed on again to investors throughout the economy. This caffeinated investing created short-term benefits for the economies many personalities (buyers, loan originators, investors, and even the government) but set the stage for the 2008 crash when the decoupled interests of these personalities came to the fore.

“Complexity so intricate no one can fathom it. Large things within small things, small things within large things—things encompassing things which would seem to be beyond them. Chaos.”

The “come to Jesus” moment when the economy’s personalities were forced to face each other was delayed by the increasing distance and complexity of the relationship. Private MBS were split apart and formed into collateralized debt obligations (CDO). As with all large asset markets, a subsidiary insurance market began to develop in the form of credit default swaps (CDS). These CDS were themselves bundled to create synthetic CDO. The housing market was able to stick together by constantly developing new coping mechanisms in the form of more intricate assets and investment tools. Anybody who took the time to look past the details could immediately see that the very MBS created as a tool to improve responsible lending to new homeowners had morphed into a set of tools hurting homeowners and benefiting investors further down the economic bread line. These complex instruments created the illusion of a great distance between the divergent personalities of the housing market for a time but when the defaults and foreclosures of regular buyers started to effect the meltdown of major financial institutions this distance was revealed to be nonexistent.

“Federal troops. The eighty-second airborne. The paratroopers. On every corner. And camps. Work camps. Put them all in work camps…But wouldn’t the presence of federal troops depreciate property values?”

Much like a lawyer drinking heavily to avoid acknowledging a midlife crisis, the government was forced to address its issues aggressively and immediately to avoid a total collapse. TARP, Dodd-Frank, and Glass-Steagall all served to rein in the behavior of financial institutions who were the final recipients of the risk of MBS transactions. Unfortunately, these regulations did nothing to reduce the complexity and distance that creates the environment where the mortgage market forgets its founding purpose of supporting a healthy housing market and instead focuses on profits on traded mortgage assets. The government’s response did succeed in the short-term in keeping the entire economic system afloat, but without addressing and acknowledging the dissonance between the economics multiple personalities the recovery did not address the long-term conflict that remains.

“That precise point when consciousness is heightened and everything glows.”

The U.S. housing market inherently has multiple personalities, this is unavoidable. Punishing investors by banning MBS entirely would be equally harmful to buyers in the market as the pool of loans would dry up. The reverse, leaving investors unfettered to create levels of security, is what created the most recent crisis. Like anybody dealing with multiple personality nondisorder, the key to staying in control is ensuring each personality has room to exist, none become too dominant, and each is satisfied in its own way. By regulating all MBS creators as BSE are regulated, the many personalities of the housing market will face the same risks and have the same goals. Investors will be able to purchase MBS with confidence knowing they are made up only of quality loans, MBS creators will face more risk and their market will shrink (sorry guys, we all have parts of our personality that we try to suppress), loan originators will have a securitization market to sell their loans to as well as buyers willing to create mortgages, and buyers who are unlikely to default, the nightmare situation for buyers as well as those who are exposed to housing market risk, will be able to receive loans and become homeowners—a sip of espresso here, a sip of wine there, and some Volvic at the end for good measure.

(All quotes are drawn from Lawrence Joseph's Lawyerland)

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