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Constitutional education, history, commentary, reform, compliance, and interpretation.

2008/10/06

Mortgage-backed security model is infirm

It should now be clear the mortgage-backed security (MBS) model is fundamentally infirm, and only undoing it will suffice, but that will be a major undertaking and has serious implications for the entire financial sector, which is going to have to get used to not being able to raise unlimited capital using smoke and mirrors.

The only effective way to sort out this mess is to separate out each mortgage note and evaluate and manage each separately. The problem is the loss of information and control that has come from first bundling mortgage notes into securities, then selling shares of the bundles in further bundles, without conveying the details of each note and the collateral that secures it.

The result of this layered bundling is that it becomes difficult to credit payments to each note, work out delinquencies with the debtors, or execute foreclosures if that becomes necessary. It is not just failures to pay that is resulting in foreclosures, but failures to credit payments made, and having service agents go out of business leaving a question of whether there are uncredited payments, and whether payments received but not credited should be considered unsecured claims of the debtor or the mortgage holder.

Most of this debacle could have been avoided had courts not allowed foreclosures without presenting the original signed note instrument in court, and required the one owner and holder of it to personally appear in court to testify. The practice of accepting "affidavits of ownership" in lieu of the physical original note paved the way for the entire catastrophe.

If local lending institutions need to raise capital to make more loans, their proper solution is to continue to be the owner, holder, collector, and manager of each note, and sell stock in their institution, or at least in bundles they retain, not selling the notes, bundled or otherwise. It has never made sense to trade in bundles containing assets that come and go as they are paid off or not. What is the value of a bundle containing paid-off notes? Or of another consisting entirely of foreclosed properties being torn apart by vandals?

There is a problem with how it can be done, constitutionally, without violating the Contracts Clause (and the Tenth Amendment, since the Contracts Clause is only a restriction on the states). I have proposed creating jurisdictions for federal Art. III or bankruptcy courts to challenge foreclosures if the original signed note, a complete record of payments received by the servicing agent, and the owner and holder of the note (not just his attorney) be required to personally testify in court (for a corporation that would be a senior official). That would require disaggregation of all those MBS, if not as securities then as transparent administrative processes that could enable evaluation not just of bundles but of each component of them, in nearly real time.

The federal jurisdictions need not overburden the federal courts, as I would expect it to impose similar judicial reform in state courts, something that has already begun.

I do not, as a libertarian, favor regulatory interventions in the sense of administrative agents directing the actions of people, setting standards, or requiring them to report on their activities. The Nondelegation Doctrine needs to be revived, not further buried. However, it would be appropriate to use grand juries to investigate the inner workings of organizations too large or well-connected to be allowed to fail. Their role would not be to enforce rules written (and probably misconceived) from the last bubble burst, but to uncover things like conflicts of interest and actions between managers and their principals. Grand juries can keep trade secrets while making things transparent that must be known for investors to make rational decisions. Unbound by specific rules, grand juries could freely seek out dysfunctions that can arise from clever managers evading any rules that bureaucrats or legislators can devise, and prick emerging bubbles that regulators are likely to be discouraged from doing.

It is worth studying the history of money and finance, going back to John Law. This kind of thing has happened before. It is what led the U.S. Founders to require in the Constitution that only gold or silver coin be legal tender (on state territory). We can question today whether gold or silver are still suited for backing currency, but it should not just be the "full faith and credit" of national governments and their ability to withdraw enough currency from circulation through taxation to offset the amount they print to pay their bills. Perhaps the world should go to backing by something like kilowatt-hours of energy or its equivalent. But not by credit instruments whose value essentially depends on continued economic growth, which will eventually falter, bringing down all or most national currencies.


8 comments:

Angela said...

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ariah said...

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jroland said...

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Lede said...

I love Constitution.org!! I have used it since college back in 1999! Don't listen to critics like Ariah, many countless Constitutional devotees favor the timeless impact and simple format. Liberty, freedom, does not require the newest HTML codes!

In Liberty,

Luke
www.ledeagenda.com
1776. Reborn.

Lede said...
This comment has been removed by the author.
Lede said...

John- in your opinion can corporations be recognized as legal persons? I have a constitionalist friend who argues that they cannot.

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