Yves Smith writes:Readers no doubt recall that the Fed announced the creation of the Term Asset-Backed Securities Loan Facility, which will lend as much as $200 billion against new or recent vintage asset backed securities collateralized by "student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration".
To attract new investors to the secondary mortgage market, in 1981 Fannie Mae began selling mortgage-backed securities (securities collateralized by cash flows from pools of mortgage loans) with a guarantee of timely payment of principal and interest, whether or not the original borrowers paid.
The Federal Home Loan Mortgage Corporation, commonly known as Freddie Mac, operates mainly by purchasing mortgages from lenders, repackaging them as mortgage-backed securities (securities collateralized by cash flows from pools of mortgage loans), and selling the securities to investors with a guarantee of timely payment of principal and interest, whether or not the original borrowers pay.
The counterparty's obligation is fully collateralized with high quality assets, guaranteeing the transaction's performance.
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"If Bear had failed," the senior official went on, "all these money-market mutual funds, instead of getting their money back on Monday morning, would have found themselves with all kinds of illiquid collateral, including C.D.O.s" — collateralized debt obligations — "and God knows what else.
But it's easy to point to other innovations that serve little purpose or that blew up and caused a lot of collateral damage, such as auction-rate securities and collateralized debt obligations.
In dealing with problems affecting arcane new financial products, including "collateralized debt obligations," "credit default swaps," and "tri-party repos," Bernanke and his colleagues have had to become expert in market transactions of baffling intricacy.
Why were collateralized debt securities bundling reckless subprime mortgages "mis-priced," as Greenspan would have it?
