All of us “hind-sight is 20/20″ folks have noted the dangers inherent in the securitizing of mortgages. In addition to all the risk factors and unknowns, this process also separates out those who originate and service a mortgage loan from those who now own the loan. In the good old days a local bank would get to know the borrower, make a thoughtful assessment as to their credit worthiness, and then stay in touch with the borrower for the length of the loan. When banks could sell mortgages to someone else, they lost the incentive to look carefully at the loan risks and also handed off the authority to do loan restructuring in hard times.

This article by Edward Glaser in the New York Times‘ Economix blog follows this discussion further – in terms of the willingness and ability of a creditor to modify the loan to avoid foreclosure. Again, in old times, a local banker could make a reasoned assessment of whether the borrower/home owner was just in temporary problems or whether the problems were longer term.

Economists have long believed that dispersed property rights can lead to a breakdown in efficient bargaining. A developer trying to assemble a land parcel owned by 100 separate owners faces immense bargaining difficulties, because one recalcitrant owner can hold up a deal that would be good for everyone. In the mortgage context, securitization has widely dispersed the rights to a mortgage’s cash flow across hundreds of bondholders. Dispersed ownership made it possible to believe that a similar breakdown in efficient bargaining might occur. Many observers took the view that the banks holding the mortgage, known here as servicers, were not engaging in sensible mortgage modification because they feared investor lawsuits. If that view is true, then there are win-win situations where loan modification can avoid foreclosure and benefit bondholders.

Insurance generally, and health insurance specifically works on the premise that if you assemble a large group of individuals, the law of large numbers will protect the insurer – we can accurately predict the number and cost of medical claims for that large population. Today’s health reform debate starts with an assumption that universal coverage will mean very large pools of insured people, and resulting lower and predictable costs – kind of like securitized mortgages. Yet large pools of people are made up of individuals, each with their own medical needs, and their own willingness to assume risk for the costs of those needs. In a sense insurance pools have become a popular tool because we couldn’t figure out how to customize a plan for a single person. (There are other reasons, too, but this is one of them.)

So, I plan to take another, closer look at the Glaser blog posting, and then think about insurance strategies in health care reform. Perhaps I can get my health economics class to wrestle this topic with me.

Here’s an example: Mankiw argues that most economists would like to see the end of farm subsidies. As an example he points to government subsidies for domestic ethanol production, coupled with tariffs on foreign made ethanol. So – when there is a subsidy to farmers, which curve (demand or supply) shifts and in what direction? If you chose the supply curve shifting to the right, you’re correct. How does that affect the price of ethanol? It lowers the price. So far, so good. However, as we’ve learned in earlier discussions and in commentary in the media, this has a pretty major impact on the market for corn. Which curve is affected in that market? The demand curve. What happens to the price of corn? It rises. And we can follow that trail to its burdensome conclusion. Oh, and as taxpayers we support these subsidies – at a pretty substantial opportunity cost.

So – try some of the other issues and see what you think.

When the Federal government imposes a luxury tax, intended to raise revenue from wealthy Americans, but finds that small business owners (builders of yachts) bear a large burden, or when city governments consider rent control, only to see the supply of affordable apartments diminish we see how hard it is for government to intervene in markets – even with laudable social goals. Dubner and Levitt add some grist for this mill.