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How mortgage securitization affected the economy


Phillip Swagel, a former assistant secretary for economic policy at the Treasury Department, teaches a class called the "The Financial Crisis" to undergraduates as a visiting professor of finance at Georgetown University.

(Photo Credit: Jeffrey MacMillan/TWP)

One of the biggest challenges for homeowners facing foreclosure is finding out what happened to their loan after they signed the closing papers. In many cases, the loans were sliced and diced and sold off as investments to buyer after buyer in a process called securitization.

At a Wednesday hearing on Capitol Hill before the House Financial Services Committee, witnesses gave differing views about securitization's role in the crisis and the recovery.

Susan Wachter, a finance professor at the the Wharton School at the University of Pennsylvania, blamed securitization for the collapse of the housing sector.

"The housing bubble was exacerbated by, but did not result from, greater demand for homes in the face of inelastic supply... Instead, it was securitizers' appetite for mortgage-backed securities that drove a 'race to the bottom.'"

Tom Deutsch, the executive director of the American Securitization Forum, spoke on behalf of 330 companies that originate, structure and invest in most of the residential mortgage-backed securities created in the United States. He argued that securitization has been good for the economy.

If financial institutions either significantly reduce or abandon securitization activity, this would "almost certainly lead to a contraction of consumer credit," he said. He expressed concern that successive waves of regulation will slow down the restart of the securitization markets and he that reinvigoration securitization is "the only" way to "significantly replace" federal guarantees.

Swagel offered a plan for reform that ensures the availability of mortgage financing while allowing for government guarantees to prevent financial catastrophes.

Swagel's plan calls for a second government guarantee to firms that securitize mortgage-backed securities made up of high-quality loans.

"This proposal eliminates the worst aspects of the previous system--uncompensated taxpayer risk, systemic threats to the financial system, lack of transparency, and undeserved duopoly profits."

Check out Swagel's proposal here.

By Ariana Eunjung Cha  | September 29, 2010; 12:07 PM ET
Categories:  Housing  
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