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476 Dissenting Statement

of mortgage securitization. Beginning in 2002, for example, the Basel regulations
provided that mortgages held in the form of MBS—presumably because of their
superior liquidity compared to whole mortgages—required a bank to hold only
1.6 percent risk-based capital, while whole mortgages required risk-based capital
backing of four percent. Th is made all forms of MBS, including PMBS, much less
expensive to hold than whole mortgages. In addition, mortgages in securitized form
could be traded more easily, and used more readily as a source of liquidity through
repurchase agreements.
However, some of the benefi ts of securitized mortgages are also detriments
when certain mortgage market conditions prevail. If housing values are declining,
losses on whole mortgages are recognized only slowly in bank fi nancial statements
and will be recognized even more slowly in the larger market. PMBS, however, are
far more vulnerable to swings in sentiment than whole mortgages held on bank
balance sheets. First, because they are more easily traded, PMBS values can be
more quickly and adversely aff ected by negative information about the underlying
mortgages than whole mortgages in the same principal amount. PMBS markets
tend to be thin, because PMBS pools diff er from one another. If investors believe
that mortgages in general are declining in value, or they learn of a substantial and
unexpected number of defaults and delinquencies, they may abandon the market
for all PMBS, causing the general PMBS price level to fall precipitously.
For example, in his book Slapped by the Invisible Hand, Professor Gary Gorton
of Yale notes that the ABX index, initially published in late 2006, for the fi rst time
gave investors a picture of how others saw the value of a selected group of PMBS
pools. Th e index showed steeply declining values, which caused many investors to
withdraw from the market. Gorton observed: “I view the ABX indices as revealing
hitherto unknown information, namely, the aggregated view that subprime was
worth signifi cantly less…It is not clear whether the housing bubble was burst by
the ability to short the subprime housing market or whether house prices were
going down and the implications of this were aggregated and revealed by the ABX
indices” 49
Whatever the underlying reason, as shown in Figure 3, this seems to be
exactly what happened in the fi nancial crisis. Th e result was a crash in the MBS
market as investors fl ed what looked like major oncoming losses.

49 Gorton, Slapped by the Invisible Hand, note 41, pp.121-123.