It seems to me that the problem with mortgage backed securities is that the risk inherent in each loan in the tranche is based on the individual’s credit risk. And that is only measured at the front end in the mortgage application and underwriting process. Even if that assessment were accurate at the time, a loan with a term of 30 years might have an average effective term of say, 10 years, due to refinance, sale of home, etc. Over that 10 year average the individuals’ personal credit risk is not static, it varies with economic vicissitudes, job losses/gains, lottery winnings, etc., and I’m not sure how this s factored into an ideal system. Far from the ideal, the amount of mortgage fraud I saw in the Atlanta area in the past 5 years was staggering. Highly questionable appraisal standards led to elastic collateral valuations which, with a wink and a nod, magically came out to 102% of the necessary value. The appraiser made his fee, the originator gambled that the highly dubious information in the application was correct and that the mortgagor would not default in the first 12 months, so there was no recourse. And the investors bought a portfolio of these loans based on something other than a real time assessment of the credit risk of the borrowers represented in the pool of loans.
Another issue ignored in this piece is the proper level of government encouragement of home ownership. There may be an optimal level of home ownership. let’s say i is 68%. Any effort by the Federal government to increase it to 69% may lead to a substantial increase in foreclosures in the ensuing years. Perhaps the market for home ownership sorts itself out by risk/ability to pay and the marginal increases in home ownership represent not a virtue - but the inducement of people who shouldn’t own homes to enter the market, destined to fail, is not a great idea, no matter how much apple pie politicians can cite about owning one’s home.