ANOTHER "FREE" MARKET FAILURE

A global hunt for mortgage loan risk
Mortgages are funded by investors worldwide,
making it hard to pinpoint trouble.
By Peter G. Gosselin, Los Angeles Times Staff Writer
August 11, 2007

Policymakers were aware that in allowing the regulated world of the banks to be supplanted by the markets, they were substantially changing the rules of the game.
They believed, however, that the market would provide its own protections.

And many of the mortgages -- written by lightly regulated brokers rather than bankers -- have turned out to be too big compared with the value of the property on which they were made.

"Mortgage lending, effectively, is not regulated," said Yale finance theorist Robert Shiller, who gained national prominence for warning of the stock bubble of the late 1990s and more recently has been warning of a housing bubble.

"Mortgage lenders have been too generous. The market is a mess," he said.

These people were so clever at packaging, no one seems to know who's holding bad paper:

With ownership and risk spread far and wide, no one investor is likely to have too much exposure if something goes wrong. But the little-recognized flip side of that reassuring strategy is that no one can be sure exactly who is sharing in the risk.

What makes that discovery a problem is that when risky loans are packaged and repackaged into ever-more complex securities and sold to investors all over the world, it's almost impossible to tell who's holding a piece of the bad paper and who's not. As a result, reassuring investors and calming jumpy markets have become very difficult.