WASHINGTON — For the better part of 15 years, the U.S. economy roared in part because of innovations in finance that vastly expanded credit to people of all walks of life and worked in the background like a computer's operating software.
Now that software has been hit by a virus, and the computer - the U.S. economy - is at risk of seizing up completely, prompting the emergency measures that the Bush administration announced last week.
What mortgage and consumer finance will look like after those measures are applied is anything but clear. And it's uncertain whether America will return to the days of easy credit to purchase a car, home or go to college.
"It's less about homeowners and keeping people in houses ...and more about getting the lending markets lubricated and stable again," said Rick Sharga, vice president for RealtyTrac, a housing research firm in Irvine, Calif.
Twenty years ago, banks kept a mortgage on their books for the life of its term. This ensured them a measure of quality control. But it also tied up their capital — meaning they couldn't lend to somebody else.
That's where a process called securitization came into play. Mortgages were sold into a secondary mortgage market, where they were pooled together — securitized — and sold to investors as a type of mortgage bond called a mortgage-backed security.
The banks got their money back and could make more loans. The investors made their money from the monthly payments that the individual mortgage holders were making.
And it wasn't just home loans that began to be "securitized." Auto loans were bundled together, allowing more money to become available for car sales. Ditto college loans. Even credit card debt was bundled together into bonds that were sold to investors.
So far, no crisis of confidence has hit those securities like home-mortgage securities have been hit. Lending standards for car loans and student loans have been tightened, giving investors some measure of comfort.
Credit card securitization remains healthy right now, in part because the big commercial banks that issue credit cards have been willing to buy up some of the riskier securitized credit card debt.
. But what happens if the U.S. economy enters into recession, and more people lose their jobs and default on car payments or stop paying off their credit cards? Will these securitized instruments fall from grace and become toxic, too?
Will investors, after ridding themselves of home-mortgage debt, decide that investing in other kinds of debt securities isn't worth the risk?
Few people believe the system of mortgage securitization will survive what is taking place now — though no one knows what might replace it.
"There is a lot of suggestion that securitization may not come back, and if it does it will be completely different," said Jay Brinkmann, chief economist for the Mortgage Bankers Association in Washington, D.C.
Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, told McClatchy whatever replaces the old form of securitization will be subject to greater regulation. He suggested that lenders are likely to be required to keep more capital on hand to cover their loans and that there will be limits to how much institutions will be allowed to borrow to buy mortgage-backed securities.
But Frank said he didn't know what the alternative to securitization would be in an economy that has become dependent on it.
. "Securitization has dissolved ," he said. "We have not come up with a sustainable" alternative.
In the real estate market, securitization exploded between 2001 and 2006, particularly of so-called sub-prime loans given to the weakest borrowers.
In 2001, there was $95 billion in mortgage bonds backed by sub-prime loans. By 2006 - the year before the bottom fell out - that sum had more than quadrupled to $450 billion, according to industry statistics.
More than one in five sub-prime mortgages are now delinquent or in default, and the deep fall in home prices nationwide made it virtually impossible for many of the homeowners to refinance.
As housing problems worsened, these mortgage-backed securities, issued largely by heavily leveraged investment banks that have since collapsed, became orphaned debt. No one wanted them, and they sat on bank balance sheets, deteriorating month after month.
Soon, with no one to buy them, questions were raised about whether banks were overvaluing them. Banks wrote down their values, but it never seemed to be enough.
Treasury Secretary Henry Paulson, who rushed to Capitol Hill on Thursday to begin pushing for a broad-based solution to the mortgage problem, has hinted at one potential solution for mortgage finance — so-called covered bonds, a system of bond financing popular in Europe, particularly in Germany, but rarely used in the United States.
Covered bond financing works a lot like a mortgage backed security. A bank or other financial firm takes a bunch of cash-paying loans and packages them together for sale to investors, who are paid off by the stream of incoming payments.
The key difference, however, is that covered bonds remain on the balance sheet of the issuer of the loan, kind of like a corporate bond, instead of passed off to some third party in a secondary market. That increases the bank's diligence in deciding who gets the money.
"The bank has a significant incentive to make sure the loans they make are good loans," said Mark Zandi, chief economist at Moody's Economy.com, an economic forecaster in West Chester, Pa.. "The flaw in the mortgage-backed securities process was that no one had enough at stake to make sure the loans were good loans. We made millions of loans that were no good."