Imagine going into a community bank and getting a mortgage but not telling the lender exactly where the house you want to buy is. You give the lending officer the zip code, and a few other clues about the home, but you walk out of the bank without having given your name or a street address.
Sounds like a scam, right?
Well, that’s how most mortgages are financed in the U.S. Investors in private, residential mortgaged-backed securities (or RMBS) are prevented by law from knowing the address for the mortgages they purchase. Naturally, a bank wouldn’t want to lend a few hundred thousand without knowing this information. We argue in a recent study by Reason Foundation that mortgage investors should be allowed the same privilege. It’s an important part of getting the housing market on a path toward recovery.
The market for mortgage-backed securities collapsed as a result of high foreclosure rates, particularly on subprime mortgages. Investors lost considerable sums on AAA rated mortgage-backed bonds and have been suing rating companies ever since.
Critics of these lawsuits are correct in suggesting that many investors failed to perform due diligence, blindly trusted the ratings system and ignored prospectuses. But even greater investor attention probably wouldn’t have prevented the financial crisis. Since RMBS investors were given only partial details about the properties backing their bonds, and the borrower address wasn’t among them, they could conduct only a limited risk analysis.