The prices of traded mortgage backed securities have followed house prices down.

Initially, there was little basis for re pricing them rationally, because the event (a peacetime decline in US house prices) was unprecedented.

Consider the following. The financial crisis erupted in 2008 when mortgage backed securities were revalued at much less than what they had been thought to be worth.

The mortgage backed securities that US banks succeeded in selling to the world are not comparable to European assets with similar names.

In 2007 2008, this was the case for a class of securities based on residential mortgages in the United States (RMBS, or residential mortgage backed securities).

Finally, the investors who bought MBS s and CDO s were greedy and believed the misleading ratings.

Its banks and financial institutions were not tempted to buy the mortgage supported securities and credit default swaps that ruined several Western financial institutions.

Moreover, holdings of RMBS migrated to institutions that were able to support and manage the remaining risk. Today, RMBS are no longer considered toxic, allowing the market to function normally again.

Even mortgage backed securities, which were at the center of the financial crisis that erupted in 2008, have important uses in spreading home and auto ownership.

The Fed is buying Treasury bonds and long term mortgage backed securities at a rate of 85 billion a month, equivalent to an annual rate of 1,020 billion.

Asymmetric information between sellers and buyers of financial products can easily leave buyers vulnerable to abuse, as we saw with mortgage backed securities.

But that means that when intervention comes to an end, interest rates will rise and any holder of mortgage backed bonds would experience a capital loss potentially a large one.

The main problem is that the flow of foreign credit has been impaired because US mortgage backed securities and the derivatives based on them have become nearly unsellable everywhere.

In the current crisis, even the private rating agencies dramatically underestimated the risks involved, which helped lure international financial investors into purchasing mortgage backed securities at exaggerated prices.

Some distressed banks clearly possess large quantities of mortgage backed securities, and are holding onto them in the hope that their prices will rise in the future, saving them from failure.

It may make sense for central banks (or Fannie Mae, America s major government sponsored mortgage company) to buy mortgage backed securities in order to help provide market liquidity.

India s banks and financial institutions were not tempted to buy mortgage backed securities and engage in the fancy derivatives trading that ruined several Western financial institutions.

When the Fed buys Treasury bonds or other assets like mortgage backed securities, it creates reserves for the commercial banks, which the banks deposit at the Fed itself.

This synthetic collateralized debt obligation (CDO) did not finance the ownership of any additional homes or allocate capital more efficiently it merely swelled the volume of mortgage backed securities that lost value when the housing bubble burst.

The Fed bought more than 2 trillion of Treasury bonds and mortgage backed securities, nearly ten times the annual rate of bond purchases during the previous decade.

Even mortgage backed securities, which were at the center of the financial crisis that erupted in 2008, have important uses in spreading home and auto ownership. The problem was not with the innovation, but with how it was used that is, with financiers incentives.

And, if the downward spiral in house prices continues, the value of mortgage backed securities held by financial institutions around the world will continue to decline, affecting the supply of credit far beyond the US.

As with RMBS, this view that public debt was totally safe was underpinned by the fact that no advanced country, at least in the post 1945 era, had ever defaulted.

Indeed, with its recent decision to pursue QE3, the Fed is focusing once again on the mortgage backed securities market but, given that the market is much healthier now, it is unclear how much good this will do.

As a result, mortgage brokers maximize their income by generating larger volumes of mortgages, as do the banks that package these loans into mortgage backed securities (MBS s).

And the market is prone to temporary fits of shared enthusiasm for emerging market debt, for Internet stocks, for residential mortgage backed securities, for Greek government debt. Traders need not wait to see when or whether the profits materialize.

For example, under the internationally agreed Basel Committee rules that were in place before the 2008 crash, capital requirements for business loans were five times higher than for mortgage backed securities that had AA or AAA ratings.

But leading banks are also accused of illegal behavior inducing people to borrow, for example, by deceiving them about the interest rate that would actually be paid, while misrepresenting the resulting mortgage backed securities to investors.

Banks everywhere are learning the hard way that the debt with which the US financed its consumption boom will not necessarily be repaid. The mortgage backed securities that US banks succeeded in selling to the world are not comparable to European assets with similar names.

The government has announced that these measures, which work (if they do work) by lowering interest rates, are temporary. But that means that when intervention comes to an end, interest rates will rise nbsp and any holder of mortgage backed bonds would experience a capital loss potentially a large one.

That left the financial institutions that held mortgage backed securities in much weaker condition, and several failed.

The US Federal Reserve, for example, is currently purchasing assets (many of them mortgage backed) worth 85 billion each month.

It involved a complex synthetic security that was derived from existing mortgage backed securities by cloning them into imaginary units that mimicked the originals.

In Europe, particularly Germany, a mortgage backed security ( Pfandbrief ) is an ultra safe asset, as normally banks finance no more than 60 of a house s value.

Collateralized debt obligations (CDOs, mainly tied to mortgages) made a new population of aspiring homeowners supposedly creditworthy by enabling the originating banks to sell sub prime debt to other investors.

What started with subprime mortgages spread to all collateralized debt obligations, endangered municipal and mortgage insurance and reinsurance companies and threatened to unravel the multi trillion dollar credit default swap market.

A Loan and a Prayer

America s financial industry polluted the world with toxic mortgages, and, in line with the well established polluter pays principle, taxes should be imposed on it.

This process consists of two steps.

To get more people to borrow more money, credit standards were lowered, fueling growth in so called subprime mortgages.

While a big US rating agency gave European companies, on average, only a triple B rating in recent years, CDOs based on MBSs easily obtained triple A ratings. According to the IMF, 80 of CDOs were in this category.

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Delinquencies, defaults, and foreclosures are now spreading from sub prime to near prime and prime mortgages. Thus, total losses on mortgage related instruments include exotic credit derivatives such as collateralized debt obligations (CDOs) will add up to more than 400 billion.

We would have heard about a long list of mortgage related instruments, which supposedly made financing available to home buyers who would not have been able to purchase homes otherwise.