First a couple of random musings

"Live life, don't just live it!" - Kara

"I don't want hillary clinton as President because women are moody" - Arlene

Now here is my long term idea for the mortgage market that will never work. The problem with the market is not the homeowners, it's not the hedgies, it's not the ibanks, it is whomever was stupid enough to let everyone leverage their asses off which leads to liquidity which is the true problem. Anything that is not liquid is essentially worthless if you need raise immediate cash.

Now the major problem with MBS & CDO's (both are also known as POS) is that they are derivatives. In theory derivatives are great - they allow people to shift risk / align risk. However the secondary issue with derivatives is the one issue that everyone overlooks - they are illiquid. Why so? Because the only people that buy them are a small coterie of sophisticated (haha) investors. So lets assume for a second that there is some issue with this security class - since all of these investors know each other - it is not hard to assume that they would all stop buying them together and thus no market. The great thing about the stock market is that anyone can buy a stock - it's simple. The great thing about buying a home is that in almost any market you can liquidate a home (maybe at a loss) but when you have very few market participants it is fake liquidity since there is no default buyers. The underlying assets supporting these MBS and CDO (POS) are not horrible - they are homes just like yours. These are great assets, even in the case of a default, it is still a real asset. Because of securitization - so many layers are added to the middle that it is almost impossible to smoothly liquidate an MBS security and therein lies the problem. If you can't cleanly liquidate then your security is really nothing but a bet on greater fools theory. Eventually the market runs out of fools.

So what would a solution be? Create a true exchange where each home loan itself is put up to auction on the market. Investors can put in preset loan characteristic for the loans they want to buy and then it would automatically create a bidding war for those loans among interested buyers. Investors would then own an actual mortgage without the need for any fancy securities - very simple. No more tranches, no more confusion finance, no more gobbly gook. If you want leverage - borrow money to buy the loans. The greatest reason for failure and total collapse are margin calls - not devaluation of their underlying security. Using this model, we will not need any credit agencies to fraudulently give their stamp of fauxproval. Instead, default risk and late payment risk would be public record with statistical tables - available from the exchange so you can determine your own risk level. If need be to satisfy investment requirements - we can put general ratings depending on loan characteristic (ie: 70% LTV, FICO 700 = AAA, 98% ltv, fico 550 = b- rating or whatever - even though the ratings will be a waste of both time and money)

Then the question is how if you are an outside investor can you service your loan and forclose? Simple, the same way it's done now by having a mortgage servicer do it for you. And if a loan goes to forclosure, it would automatically go onto nationwide MLS listings and of course be available for purchase by anyone in the exchange. So perhaps a pension fund also sets its presets to acquire any foreclosed property as long as they don't pay more than 70% of appraised value. And then we can allow local RE agents to be secondary participants to resell foreclosed property for investors at a profit.

What is the end result? We have a true exchange with real liquidity based on real assets and involving no hocus pocus finance. The whole loans will be individually sold & traded instead of pools of them. Or even pools will be traded however they will not be fully packaged and will be easy to take apart peicemeal should they need to be liquidated. Also, they would be valued because we would have ongoing real time statistics on default/collections, which would then be factored into valuation mechanisms that each investor determines.

The final product is a 100% liquid market that will never run dry as long as there is a market for real estate.

Yes i also admit there is a demand for swaps to align borrowing & lending types. (fixed v variable) and for certain situations. Yes, swaps could still exist in this market but it would be a loan for loan swap - with realistic chance of liquidation should something go to hell. Swaps would work automatically the same way loans are sold. Also there would be no reason to hold (season) loans anymore since they can go right into the market (unless your loan just sucks). We just eliminated mortgage banking risk as well as liquidity risk and what I will dub Idiots Risk (being stupid enough to buy something that you don't fully understand.