Toxic Mortgage Pools

You probably heard a description of the recently proposed $700 billion rescue plan as cash for trash. This plan calls for the Treasury to purchase from financial institution mortgage backed security that are completely illiquid; nobody want to buy them. You may want to ask why is that that these securities are untouchable. The answer lies in the uncertainty surrounding the cash that will ultimately will flow from them. As more borrowers whose mortgages are part of the pool default, the less is the payoff from the securities backing the pool. This is not a problem for conventional (or prime) loan whose cash flows are now guaranteed by the U.S. Treasury. Subprime loans that were securitized by private banks are at risk; they are not protected from borrowers defaulting.
Yesterday's New York Times had an EXCELLENT description of the toxicity of one mortgage pool. Please read this article titled "Plan’s Mystery: What’s All This Stuff Worth?" Make sure to examine carefully the multimedia table in this article.
Once you read this article, you will be able to understand why (in my opinion) the $700 billion rescue plan will reap off the tax payers. Suppose a bank is currently holding securities from two different pools:a high quality Pool I and a low quality Pool II. The bank cannot get rid of either one of them because buyers believe that the bank will try and get rid of the bad pool first. George Akerloff was awarded a noble prize (2001) for this idea (he titled his article "The Market for Lemons"). Enter the cash for trash program: the banks can now sell to the Treasury either the Pool I or the Pool II security. Which one do you think the Treasury is going to end up owning?