A year ago, however, with the subprime mortgage meltdown of August 2007, I became certain.

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

And essentially the same happened with US subprime mortgage lending and with the Spanish banking system in the 2000 s.

After the subprime crisis erupted, mortgage and consumer debt was paid down by households either with their savings or by default.

Indeed, subprime mortgage lending delivered illusory wealth increases to Americans at a time when they were suffering from stagnant or falling real wages.

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).

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).

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

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.

True, major commercial banks, like Citibank and Bank of America, tottered, but they were not at risk because of their securities underwriting for corporate clients or their securities trading divisions, but because of how they (mis)handled mortgage securities.

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

The impetus for a big subprime market came from within the private sector innovation by giant mortgage lenders like Countrywide, Ameriquest, and many others, backed by the big investment banks.

After all, when the global financial crisis erupted in 2008 from the bowels of the American subprime mortgage market, global investors responded by fleeing to the US, not from it.

Debt relief created fewer problems for banks in the US because a significant proportion of the subprime loans packaged into AAA rated securities had been sold to gullible foreigners.

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

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.

Europe s Subprime Quagmire

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

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

Even so, the explosion in the quantity of collateralized debt obligations and similar securities went far beyond what was needed to sustain mortgage lending.

That way, they would share the pain if the securities are not serviced and thus gain a powerful incentive to maintain tight mortgage lending standards.

The crisis spread because the banking system was not sufficiently risk averse and in some cases even seemed to relish risk. Mortgage banks kept some claims on their books, but sold most of them to investment banks as mortgage backed securities.

An audit would also reveal more details about financial market interventions like those in 2008, when the Fed purchased mortgage securities from Bear Stearns and AIG.

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.

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.

Sub Saharan Africa s Subprime Borrowers

The Fed has explained that it will sell the large volume of mortgage securities that it now holds on its balance sheet, absorbing liquidity in the process.

In Mexico, the market for new low and middle income housing has grown rapidly, thanks to the creation of a market for residential mortgage securities in 2003.

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.

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.

MUNICH Once upon a time, stocks were risky and collateralized securities were safe. That time is over, as the breakdown of the American mortgage securitization market has shown.

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.

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.

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.

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.

The main problem with US mortgage based securities is that they are non recourse. A CDO is a claim against a chain of claims that ends at US homeowners.

In the US, the low risk assigned to senior tranches of mortgage backed securities made them attractive instruments for banks to hold, given the relatively high return they offered.

We then call on credit rating agencies to certify that the less risky of these mortgage backed securities are safe enough for pension funds and insurance companies to invest in.

From 2000 through 2007, millions of American homeowners entered into mortgage contracts to finance their homes. Securities based on those contracts ended up, in part, in the hands of financial institutions.

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.

The policy and regulatory mistakes that contributed to the subprime mortgage crisis and thus to the US financial system s near meltdown and the eurozone s travails have brought the issue of optimal economic regulation and its relation to democracy to the fore once again.

Declining house prices are key to the financial crisis and the outlook for the economy, because mortgage backed securities, and the derivatives based on them, are the primary assets that are weakening financial institutions.

Standard Poor s analyst Juan Pablo de Mollein points out that Mexico does not have a liquid secondary market where mortgage securities can be traded to buyers who are far removed from the original issuer.

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.

Banks naturally avoided traditional business loans (which would have to be backed by more capital), and instead loaded up on the highest yielding and thus riskiest AA or AAA mortgage backed securities that they could find.