Something new to consider:
Second mortgages, which in the case of default only get paid after the first mortgages are paid off were more likely than first mortgages to be held on the banking books. This challenges the idea that the securitization of mortgages was what caused the problem because even though these securities had more risk than first mortgages the banks held on to them. If banks knew mortgages were risky then why did they hold on to the riskiest ones? This isn’t like the the super senior tranches of CDOs that the banks lost billions on. Those losses were tail risk (that a lot of them could go belly up at once). That is, those structures lost money in the event of huge falls in many home prices which could have been a low probability even but unfortunately which happened. But second mortgages were held outside of CDO and ABS structures. As such, banks lost money on the first dollar of housing losses and would lose money dollar for dollar as people defaulted on their second mortgages. The trillion dollar question is why did do it?
HT: The second-mortgage underwriting failure
Maybe this is why:
When mortgage modifications like Hamp [Home Affordable Modification Plan] come into play, that traditional priority order is reversed. The borrower is paying the Hamp-modified (i.e. lower) first lien amount, and the full second lien amount, so the second lien effectively becomes senior to the first.
The second lien sticking-point
If banks were getting a higher rate of interest and knew in the event of any mortgage modification that they would be made whole, maybe they’d get paid enough to take that extra risk. But given that almost no mortgages have been successfully modified, and the HAMP rules were put in place afterwords, how could banks have expected that to bail them out? And if secondary lien banks are getting such a great deal out of HAMP, why are so many seen as an obstacle to putting in place modification plans?
This leaves us with many new questions and no new answers. It could well be a generation or longer before we really understand what caused this financial crisis.
Update from a comment I cam across:
Just because liens are on commercial banks’ balance sheets of banks doesn’t mean that they weren’t securitized.
The ABS issuers in the thin purple slice = investment banks. The question is a legal one: who is the holder of a lien once tranches of an ABS have been sold? Is the lien holder (a) the ABS issuer, or (b) the investors in the ABS (including commercial banks)?
If (b), then the thin purple slice merely represents unsold ABS inventory still in the hands of investment banks. If (a), then it does seem as if second mortgages were not securitized and remained in the hands of originating banks.
