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Edited on Sat Sep-20-08 11:53 AM by HamdenRice
The most important thing to keep in mind is that before the crisis, mbs was considered fungible, interchangeable and almost as safe as cash or treasury bills.
When the subprime crisis hit, suddenly banks realized there were differences, and some were as good as cash and others weren't. That caused the market to freeze up. Then the overall mortgage market crisis occurred and yet more mbs were bad.
One former Treasury official put it this way: if you went into 7-11 knowing that one in one hundred bottle of bottled water had poison in it, but couldn't know which one, would you buy any bottled water?
Of course not.
Right now the banks, have to do thousands of back and forth transactions with each other. In the past, they would use mbs like cash, to do so. Now, most banks won't take other banks' mbs. That has caused a freeze up in interbank transactions.
The mbs that the feds will be buying will be ones banks think are in default and need to do transactions with other banks.
So the govt is going to buy them, go through them, test which ones have poison and resell them as clean.
The way they will know what's in them is that each mbs was created and sold with a document that contains a very, very detailed explanation of what's in them. That document is called a "prospectus." By studying the prospectus, the feds will be able to determine precisely what is in the particular bundle of mortgages that make up the mbs.
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