If Banks MUST keep their CDSs here's a way to remove the risk of another housing bubble

[Bill USA]

34. Fannie and Freddie started buying mortgages in the 1980's. Securitization of mortgages was going

along okay until Morgan Stanley invented the Credit Default Swap in 1997. Then, Phil Gramm, at the behest (not unremunerated) of Wall Street banks, made trading in CDS by banks unregulated (he slipped the Commodities Futures Modernization Act in as a rider to the Omnibus Spending Bill 2000 in the waning days of the last Clinton administration. Nobody even knew they were voting for the CFMA as they voted to fund the Government for the next year.). The CFMA made trading in CDSs legal AND UNREGULATED. CDSs made CDO tranches of high risk/return much more marketable as the CDSs would insure the investing fund that if his tranche went south the CDS he was holding would pay off and he would not lose his money! (that's the way it was supposed to work).

This made the securitization of high return (subprime) mortgages a hot market to be in (higher return with 'no' risk of loss of your investment, oh boy!). Wall street wanted all the subprime mortgages predatory lenders could flip. Wall Street banks leaned on credit rating agencies (S&P, Moody's) to give their CDOs ridiculous ratings to make them an easier sell (at better prices) to investors. Investors saw a chance to make higher returns without any additional risk - because they also bought a CDS to cover their investment in the high risk CDO. It was great fun. The party really got going about 2004 or so. It lasted about 4 more yrs and then it all blew up.


... but mortgages were written before securitization came along. But securitization is not a bad thing in itself. When the mortgage originator is able to off-load all the risk of a given mortgage, that incentivizes bad behavior. CDSs also makes selling high risk CDOs more marketable and this all needs to be regulated but especially the mortgage originator should not be allowed to off-load all the risk of a given mortgage.