depositories are not capable of holding long-term fixed-rate mortgages, because it subjects them to too much duration risk: mortgages are assets with long duration (i.e., have values that are sensitive to changes in interest rates), while deposits are liabilities with short duration.
...the basic MBS [mortgage-backed security] was and remains an ingenious product, and will continue to be an important instrument of housing finance in the years to come.
We are not exactly in agreement here. Some quick points.
1. The mortgage security does not make duration mismatching go away. To the extent that mortgage securities wind up held by banks (where they get a generous risk rating from regulators), the duration problem is right back where it started.
2. If Freddie and Fannie hold the securities (which they increasingly were doing), then you get a highly leveraged, highly concentrated pile of mortgage securities. This was a financial land mine waiting to be stepped on, and this summer it blew up.
3. If there are natural holders of long-term assets (pension funds or insurance companies), then there is nothing stopping banks from issuing long-term debt. Then banks can more safely fund long-term mortgages.
The financial system I want to see around mortgages is many banks, holding loans that they originated themselves, with decent-sized down payments (you don't get such big housing bubbles when people put down 20 percent), and with sufficient capital to ensure that shareholders and not taxpayers are the biggest losers if the bank messes up. This is pretty much the system that existed in 1968, prior to securitization. It blew up in large part because inflation got out of control, so that long-term interest rates rose, destroying the value of fixed-rate mortgages. So part of my ideal system of mortgage finance is that the Fed doesn't lose control of the inflation rate again. I think that's a lot easier to orchestrate than a system to try to put back together the Humpty-Dumpty of the mortgage-backed securities market.