The dubious mortgage securities are so called mortgage backed securities.

The current crisis originated in the subprime mortgage market.ampnbsp

The issue centres on the sale of mortgage securities.

A year ago, however, with the subprime mortgage meltdown of August 2007, I became certain.

The prices of traded mortgage backed securities have followed house prices down.

Mortgage banks kept some claims on their books, but sold most of them to investment banks as mortgage backed securities.

Mortgage backed securities were urged onto investors for whom they were too risky.

The investment division of the bank had gambled on subprime securities and was forced to write off billions.

Hungry for growth, the bank itself and a hedge fund founded by the bank invested in US subprime securities.

Paulson s proposal to purchase distressed mortgage related securities poses a classic problem of asymmetric information.

Mortgage banks kept some claims on their books, but sold most of them to investment banks as mortgage backed securities. The investment banks blended these securities into asset backed securities and collateralized debt obligations (CDOs) and sold them on to financial institutions throughout the world.

After the subprime crisis erupted, mortgage and consumer debt was paid down by households either with their savings or by default.

As a result, mortgage brokers maximize their income by generating larger volumes of mortgages, as do the banks that package these loans into mortgage backed securities (MBS s).

It may make sense for central banks (or Fannie Mae, America s major government sponsored mortgage company) to buy mortgage backed securities in order to help provide market liquidity.

The mortgage backed securities that US banks succeeded in selling to the world are not comparable to European assets with similar names.

That gave the Fed the ability in 2010 to begin its massive monthly purchases of long term bonds and mortgage backed securities.

This creates an incentive to default, which increases foreclosures and lowers the value of the mortgage backed securities on financial firms books.

In order to ensure that mortgage securitizers have some skin in the game, they are required to retain an interest in 5 of the mortgage securities that they create (unless they qualify for an exemption).

Asymmetric information between sellers and buyers of financial products can easily leave buyers vulnerable to abuse, as we saw with mortgage backed securities.

Even so, the explosion in the quantity of collateralized debt obligations and similar securities went far beyond what was needed to sustain mortgage lending.

When home prices stop rising, recent homebuyers may lose the enthusiasm to continue paying their mortgages and investors lose faith in mortgage backed securities.

It involved a complex synthetic security that was derived from existing mortgage backed securities by cloning them into imaginary units that mimicked the originals.

The impetus for a big subprime market came from within the private sector innovation by giant mortgage lenders like Countrywide, Ameriquest, and many others, backed by the big investment banks.

Securing Synthetic Securities

It developed into a vast machine that packaged up securities based on US mortgage credit and passed them on while itself continuing to bear risks.

The subprime induced storm ended that fair weather complacency.

In Mexico, the market for new low and middle income housing has grown rapidly, thanks to the creation of a market for residential mortgage securities in 2003.

It involved a complex synthetic security that was derived from existing mortgage backed securities by cloning them into imaginary units that mimicked the originals. This synthetic collateralized debt obligation (CDO) did not finance the ownership of any additional homes or allocate capital more efficiently it merely swelled the volume of mortgage backed securities that lost value when the housing bubble burst.

In the current crisis, even the private rating agencies dramatically underestimated the risks involved, which helped lure international financial investors into purchasing mortgage backed securities at exaggerated prices.

But lower short term interest rates have led to higher medium term interest rates, which are more relevant for the mortgage market, perhaps because of increasing worries about inflationary pressures. It may make sense for central banks (or Fannie Mae, America s major government sponsored mortgage company) to buy mortgage backed securities in order to help provide market liquidity.

Weak Labor, Strong Securities Markets

So far, the sub prime crisis has had a limited direct impact on Latin America s mortgage markets. In Mexico, the market for new low and middle income housing has grown rapidly, thanks to the creation of a market for residential mortgage securities in 2003.

We then call on credit rating agencies to certify that the less risky of these mortgage backed securities are safe enough for pension funds and insurance companies to invest in.

In the US, the penalties have been dominated by fines for sales of misleadingly marketed mortgage backed securities, often to the two government supported entities Fannie Mae and Freddie Mac.

We then call on credit rating agencies to certify that the less risky of these mortgage backed securities are safe enough for pension funds and insurance companies to invest in.

Some distressed banks clearly possess large quantities of mortgage backed securities, and are holding onto them in the hope that their prices will rise in the future, saving them from failure.

This, of course, is just the story of subprime mortgages in another guise.

What started with subprime mortgages spread to all collateralized debt obligations, endangered municipal and mortgage insurance and reinsurance companies and threatened to unravel the multi trillion dollar credit default swap market. Investment banks commitments to leveraged buyouts became liabilities.

Poor s analyst Juan Pablo de Mollein points out that Mexico does not have a liquid secondary market where mortgage securities can be traded to buyers who are far removed from the original issuer.

Standard Poor s analyst Juan Pablo de Mollein points out that Mexico does not have a liquid secondary market where mortgage securities can be traded to buyers who are far removed from the original issuer.

UBS had gaps in its US mortgage products.

The market for such securities has now vanished.

Securities took the place of traditional bank credits.

And, if the downward spiral in house prices continues, the value of mortgage backed securities held by financial institutions around the world will continue to decline, affecting the supply of credit far beyond the US.

First, investors, recognizing that the dollar is overvalued and that they are likely to suffer large losses when it returns to its fundamental value, could start selling their Treasury bonds, corporate bonds, and mortgage backed securities.