This overnight market was – and remains – huge, rivaling the size of the entire deposit-based banking system.
Regulators want to make sure that banks pay off the overnight mortgage pools first. That way, the overnight mortgage-pool buyers are less likely to get spooked, rush to their cars, and clog up the evacuation route at the first sign of trouble at a single bank.
But what if overnight mortgage-pool buyers decide, in the face of a crisis, that it is not worth waiting around to find out whether the highly complex mechanisms meant to ensure that they are paid will work as planned?
What if they’re worried about the entire mortgage-pool market and not just the safety of a single bank? They could flee en masse – and take their cash with them.
If those who use overnight mortgage pools receive priority over other creditors, as is the case today, the short-term market for housing securities will surely grow.
The result could well be even greater bank dependence on mortgage pools, which are safe enough taken separately, but, together, render the entire system more fragile.
Mark Roe, professor at Harvard Law School, Project Syndicate, 31 January 2017