Re: S&L mortgages

[DORR@xxxxxxx]

There are two issues here: current and history.  Current first.  With all the
bank derregulation in the 1980's, the distinctions betweeen S&Ls and other banksare largely gone - your student is right.  When an S&L makes a new loan, it
almost immediately "bundles" it with other loans and sells it on the
secondary market.  The bundle then gets bought and sold as if it were a bond.
As interest rates change, the price of the "bonds" adjust.  Whoever holds the
"bond" at that point carries the interest rate risk.  On the deposit side,
S&L
can now take in lots of types of deposits, checking. saving, CDs,
brokered deposits, etc.  This allows more access to funds, but much higher
withdrawl risks.  In this new environment, many S&L managers are in over
their heads - don't do well - and fail.

The history part.  Most mortgages are 30 year fixed, and have low interest
rates (relative to current).  If these rates are below deposit rates, the
S&L losses money daily on the difference.  If this goes on long enough the
bank fails.  If they try to bundle these and sell them, as Marsh points out
they must do this at a deep discount, losing a lot of money on that deal, and
potentially fail.  So who ends up holding the bag?  A lot of the 'bag' is
held by the RTC.  They sell off these mortgages at a discount to other banks.
We the tax payer make up the difference.  Bottom line,  much of the problem
has been dumped on the public.

The best source on all of this at the principles level is the reader from
Dollars and Sense:  Real World Banking.  No one should try to teach macro
without at least reading this.  Better yet, make it required reading for
the class.  I've done this for two years and my students love it.

Doug Orr
dorr@xxxxxxx