Lloyd Blankfein, CEO of Goldman Sachs must have been relieved that a senate subcommittee chose to believe the combative testimony he provided on his firm’s trading activities against its own clients. Despite overwhelming contradictory evidence.

No doubt Mr. Blankfein has easily and in a way successfully defended himself against the ire that his firm has so assiduously acquired. As such, I’ll save my sympathy for those not in the position to claim their innocence. Specifically, I’m referring to the much hated Mortgage Backed Securities (MBSs) that have been placed at the center of the financial crisis.


Prior to 2007, most of us had no idea what these MBSs were. But today, they are known as culprits that almost derailed the world economy. This is rather unfortunate as by their nature, these complex financial instruments are in fact innocent of that which they are being accused. In the larger scheme of things their immense power is structured for the public good. Just like nuclear power and croquet mallets, they are only as dangerous as when placed in the hands of those who abuse or misuse their purpose.

It’s certainly true that mortgage backed securities help to facilitate the offloading of risk, encouraging mortgage providers to wake sleeping derelicts long enough to sign a loan agreement, an exposure subsequently transferred to end investors. But that was never the true purpose of a MBSs nor does it represent the real value they provide to the economy.

A mortgage backed security is like any other asset-backed security in that it’s a basket of yielding assets, typically debt. On their own, automobile leases and student loans and condominium fees are hard to trade. One could argue that this is a good thing; that those who stake loans should stand by them and price the risk on the ground. But that’s the whole point of asset-backed instruments — efficient pricing is impossible if the financing institution has to factor in the cost and limitations of raising capital from deposits. The best deal for the borrower, the creditor and the economy at large is achieved when the long-term yield of a basket of debt can be matched to the long-term goals of an investment body like a pension fund or bond.


Mortgages packaged as financial instruments are brought to you by the Federal Housing Act of 1934 which also introduced fixed-rates and Fanny Mae — the government sponsored securitization trust and single greatest progenitor of Residential Mortgage Backed Securities (RMBSs).These innovations are why bus drivers can afford houses in the US and are almost single-handedly responsible for the enormous role that housing starts have played in the most stable and sustained period of growth in the history of making stuff and selling it. RMBSs furnish providers and borrowers and you and me with one of the most important pillars of a civilized and sophisticated economy — access to capital.


The problem with MBSs is this: they are extremely complex. And therein lies the problem. MBSs are inherently difficult to value because they’re by definition composed of many different, albeit similar, things. This has been compounded by the introduction of tranches (which intentionally combine different levels of risk into one instrument) and monoline insurance policies (against the underlying mortgages not paying off) which sound too good to be true because they’re too good to be true. These distractions seem suspiciously deliberate and were certainly overkill — the ratings agencies were happy to stamp Triple A ratings on anything they could see through the smoke screen. The investment houses did as much due diligence as you’d give a decision to supersize.

Vilifying mortgage-backed securities for their role in the subprime crisis is like condemning bridges because you were duped into buying the Golden Gate. Certainly in the hands of the greedy and incompetent MBSs are a lethal weapon. They’re dangerous and complex and huge but so are jet engines and most of us agree that they’re quite useful. In any case MBSs don’t need much of anybody’s help. While between 2008 and 2010 a dearth of liquidity and understandably cold feet on the part of institutional investors put a decided damper on the market, the Securities Industry and Financial Markets Association (SIFMA) estimates that in 2012 the market for MBSs will be worth over $5 trillion. Quantitative easing by the US treasury is the catalyst for this record high but investors will always be drawn by the unsung loyalty and utility of the mortgage-backed security.