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Peter J. Wallison 475

PMBS are Connected to All Other NTMs Th rough Housing Prices
But this does not mean that only the failure of the PMBS was responsible
for the fi nancial crisis. In a sense, all mortgages are linked to one another through
housing prices, and housing prices in turn are highly sensitive to delinquencies and
defaults on mortgages. Th is is a characteristic of mortgages that is not present in
other securitized assets. If a credit card holder defaults on his obligations it has little
eff ect on other credit card holders, but if a homeowner defaults on a mortgage the
resulting foreclosure has an eff ect on the value of all homes in the vicinity and thus
on the quality of all mortgages on those homes.
Accordingly, the PMBS were intimately connected—through housing
prices—to the NTMs securitized by the Agencies. Because there were so many
more NTMs held or securitized by the Agencies (see Table 1), their unprecedented
numbers—even in cases where they had a lower average rate of delinquency and
default than the NTMs that backed the PMBS—was the major source of downward
pressure on housing prices throughout the United States. Weakening housing
prices, in turn, caused more mortgage defaults, among both NTMs in general and
the particular NTMs that were the collateral for PMBS. In other words, the NTMs
underlying the PMBS were weakened by the delinquencies and defaults among the
much larger number of mortgages held or guaranteed as MBS by the Agencies.
In reality, then, the losses on the PMBS were much higher than they would
have been if the government’s housing policies had not brought into being 19 million
other NTMs that were failing in unprecedented numbers. Th ese failures drove down
housing prices by 30 percent--an unprecedented decline—which multiplied the
losses on the PMBS.
Finally, the funds that the government directed into the housing market in
pursuit of its social policies enlarged the housing bubble and extended it in time.
Th e longer housing bubbles grow, the riskier the mortgages they contain; lenders
are constantly trying to fi nd ways to keep monthly mortgage payments down while
borrowers are buying more expensive houses. While the bubble was growing, the
risks that were building within it were obscured. Borrowers who would otherwise
have defaulted on their loans, bringing an end to the bubble, were able to use the
rising home prices to refi nance, sometimes at lower interest rates. With delinquency
rates relatively low, investors did not have a reason to exit the mortgage markets,
and the continuing fl ow of funds into mortgages allowed the bubble to extend
for an unprecedented 10 years. Th is in turn enabled the PMBS market to grow to
enormous size and thus to have a more calamitous eff ect when it fi nally collapsed. If
the government policies that provided a continuing source of funding for the bubble
had not been pursued, it is doubtful that there would have been a PMBS market
remotely as large as the one that developed, or that—when the housing bubble
collapsed—the losses to fi nancial institutions would have been as great.

PMBS, as Securities, are Vulnerable to Investor Sentiment

In addition to their link to the Agencies’ NTMs through housing prices, PMBS
were particularly vulnerable to changes in investor sentiment about mortgages.
Th e fact that the mortgages underlying the PMBS were held in securitized form
was an important element of the crisis. Th ere are many reasons for the popularity