Why Bernanke Is Wrong On Mortgage-Backed Securities

Oh no, Federal Reserve Chairman Ben Bernanke wants more taxpayer dollars to bailout the upper-class. He doesn’t actually say that, of course, but what else would be the result if the government — us — starts to buy mortgage-backed securities from poor, down-trodden investors who hold billions of dollars in mortgage-backed securities?

In basic terms a mortgage-backed security or MBS is created from thousands of mortgages bought and put together by a Wall Street packager. Investors don’t usually buy the entire security, instead they purchase interests — or “tranches” which reflect a certain level of risk and size. Buyers are supposed to examine their investments with care, make use of external ratings firms (which turned out to be largely wrong) and use MBS “enhancements,” a term largely meaning insurance. Unfortunately, the folks who sold insurance-that-was-not-called-insurance (because then it would be subject to state regulation) did not set aside sufficient money for losses (as the states would have required) — so when there were investor losses there were not enough dollars to cover the claims.

Happily the Federal Reserve stepped in and bought MBS investments worth $1.4 trillion with your money. Now the Fed is thinking of buying more mortgage-backed securities.

Speaking at a news conference yesterday, Bernanke said it would be a “viable option” for the Federal Reserve to buy mortgage-backed securities from investors.

No Risk

Translating this comment into plain language and the impact on your wallet, here’s what it means: You’re going to lose and huge investors are going to win. Here’s why:

Investors with troubled mortgage-backed securities could sell their interests to Uncle Sam at face value. This means that once sold the investors would have 100 percent of their cash and the Federal Reserve would have pretty pieces of paper.

In effect, the federal government is assuring that MBS investors will have no risk. If the securities are good there’s no reason to sell. If the securities are bad, taxpayers will buy the paper and face any losses. For investors, it’s heads we win but if we come up with tails then it’s taxpayers who lose.

Why Bernanke is Wrong

But wait, wouldn’t mortgage rates remain low or actually fall if the federal government bought out the holdings of mortgage-backed investors?

“I believe we should move back up toward the top of the list of options the large-scale purchase of additional mortgage-backed securities (MBS),” said Federal Reserve Governor Daniel K. Tarullo in October, “something the FOMC first did in November 2008 and then in greater amounts beginning in March 2009 in order to provide more support to mortgage lending and housing markets.”

This is one argument made in favor of Mr. Bernanke but it doesn’t make a lot of sense. There’s no need to lower mortgage rates, they’re already at or near historic lows. Moreover, low rates are no favor to retirees or savers, another battered class of taxpayers.

Bernanke is wrong on the issue of buying mortgage-backed securities because it’s the security buyer’s job to invest smartly and it’s not the job of the US taxpayer to bail them out if they’re wrong. Somehow, for all the stated concerns about “moral hazard,” such worries never seem to apply to institutions and foreign governments with billions of dollars on the line. What Bernanke proposes is simply still-another bailout for Wall Street, more risk for taxpayers and more evidence that the banking system remains deeply troubled.

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