Christopher Whalen, managing director of Institutional Risk Analytics, first predicted the collapse of the mortgage-backed security market in 2007. Now he is predicting that another bubble is forming and will probably burst, Bloomberg reported.

This time the bubble is in structured notes. Structured notes, which are derivatives packaged with bonds, are sold to accredited buyers in private deals and to the public in trades reported to the Securities and Exchange Commission. Sales to individual investors rose 72% from a year ago to $29.6 billion.

It was a marvelous invention, this thing we called "securitization." Another word that is thrown about is "mortgage backed securities." Mortgages were packaged together and resold to large investors and pension funds.

Why in the first seven years the securitization market just went wild. By 2007 Citigroup, Inc. (C) estimated that $8,000 billion worth of assets were securitized which represented more than half of all the credit created in some sectors. And there were tubs of champagne all over the place.

Like any other bubble, it burst.

Last year, American International Group (AIG) lost up to $2 billion because its Financial Products group unwound most of its remaining trades with Goldman Sachs (GS). Of course, this was the situation that led to the insurer's near-collapse in September 2008. The losses sustained last year resulted from AIG's continued efforts to extract itself from a precarious financial situation.

AIG's realized losses came on approximately $3 billion in mortgage-collateralized debt positions. After last year's extrication, AIG has $1.3 billion in CDOs with Goldman Sachs, because the company believed the positions could perform better than their current prices would reveal.

The Federal Reserve picked up a $52.1 billion profit last year, a record for the organization. The result is due largely to its 2009 bailout efforts. Of the profit generated, $46.1 billion will be handed over to the Treasury Department -- the largest profit payment made since records began back in 1914. The previous record was $34.6 billion, in 2007. Last year, the Fed turned $31.7 billion over to the Treasury Department.

According to the Associated Press, the profit didn't come from the $700 billion lent to financial institutions -- and then to auto companies like General Motors. Rather, it was the result of earnings from the securities it had in its portfolio last year. Several investment programs were launched last year to help kickstart the U.S. economy and drive down rates on mortgages and consumer debt. Through the programs, the Fed bought $300 billion in government debt, and under another, it's on a trajectory to buy $1.25 trillion in Freddie Mac and Fannie Mae mortgage securities.

Investment-grade commercial real estate prices gained 4.4% in the third quarter of this year. But, it's hard to tell if -- like brief blips of hope we've seen in consumer spending, unemployment and even luxury meals in London -- this is a change in the market or just a tease.

This increase in the MIT Center for Real Estate's transaction-based index (TBI) is the first up-tick in more than a year and the biggest gain since the middle of 2007. One quarter doesn't make a trend, cautions David Geltner, director of research at the MIT Center for Real Estate, but he says, "this is the strongest sign of a bottom that we've had in two years." The TBI reached 36.5% below its 2007 peak last quarter, up from 39% from the high-water mark in mid-2007.

If you've become comfortable with the current state of the housing market ... don't. Economists at Goldman Sachs (NYSE: GS) and Bank of America's Merrill Lynch (NYSE: BAC) say there's still plenty of risk in the housing market.

Alec Phillips, the head of Goldman's Washington office, said, "The risk of renewed home price declines remains significant." His "working assumption" is a drop of between 5% and 10% by the middle of next year.

In the film version of Tennessee Williams' 'Cat On A Hot Tin Roof' (1958), Maggie 'The Cat' (Elizabeth Taylor), knows her husband Brick (Paul Newman) is hiding something, but she can't figure out what it is.

Later, we learn that Brick is hiding the truth about his father, millionaire Big Daddy (Burl Ives), and he slowly gathers the courage to end the mendacity that has permeated their lives.

At some point the nation will, likewise, end the mendacity about American International Group (NYSE: AIG) and announce the full, probable cost of the orderly stabilization of AIG. For economic conservatives, market absolutists, most Republicans, and others who oppose government intervention, the above would be bad news, but at this juncture, it appears to be unavoidable.

Investors should not read too much into the Dow's nearly 400-point drop Tuesday. What they should concentrate on, in the view of a pair of economists, is the mechanism the U.S. Treasury uses to price toxic assets.

The above is the most important 'unknown' in the U.S. Treasury's financial stability plan, so says economist David H. Wang -- how toxic assets that are clogging banks' balancing sheets and restricting credit -- will be priced.

"Will the United States government set-up a clearinghouse? Or will they design some type of open outcry, or managed open outcry? These are the key unknowns," Wang said. "Treasury Secretary Geithner and his staff cannot rush this decision, but on the other hand they cannot take two quarters to developed it. They have to announce the structure of the pricing program within a couple of weeks. I cannot underscore enough the importance of this pricing methodology. It will be the biggest factor in whether the credit system recovers, or something much worse occurs."

While Washington wrangles over $820 billion to stimulate the economy, the Fed and the Treasury have already invested or guaranteed $9 trillion to keep the financial system from imploding. For some strange reason, this much bigger figure seems to fly out the door with no public debate; little clear idea of how it's being spent; or what benefit it's creating. Now the Treasury is poised to announce its own plan to rescue the financial system. I think that plan needs work.

However, the Treasury plan will not be announced as originally scheduled on Monday because there seems to be a concern that it would complicate the passage of the stimulus plan. Meanwhile, Goldman Sachs Group (NYSE: GS) has estimated that it would cost $4 trillion to absorb all the banks' troubled mortgage and consumer debt.

Will Treasury propose a plan to use government funds to do this absorbing? If so, it would mark the biggest example in American history of letting private interests reap profits from their bad decisions -- in the form of keeping their bonuses which total about $100 billion over the last several years -- while sticking the public with the resulting losses which so far exceed $1 trillion.

Washington Post business columnist and Pulitzer Prize-winner Steven Pearlstein reminds investors that a complex financial crisis will not be solved by a simple solution.

Hence, Pearlstein's offered a four-part solution that he believes will get the United States back on the road to financial health.

The first involves a limited guarantee against default by the federal government for packaged loans that circulate in the "shadow" banking system, such as the way Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) do with conventional mortgage-backed securities. The FDIC is working on plan to do the above, he said, funded by either bank fees or via a modest contribution from the $700 billion TARP.

Second, the FDIC, via a new program that covers $1,000 in refinance closing costs, should be able to encourage more banks to renegotiate at-risk mortgages, greatly reducing the number of home foreclosures that are at the root of the bad bond/toxic asset pipeline.

Comment: The view from here argues that had the FDIC under chairwoman Sheila Bair been allowed to implement a version of the above program a year ago, the U.S. would have been that much closer to reducing foreclosure rates. The previous presidential administration did not act swiftly on Bair's proposal -- an unmitigated policy error that the current administration inherited. Hopefully, the Obama administration will correct it.

U.S. policy makers are putting all hands on deck. All engines are being used to pull this train out of the station. In this case, nearly every cliché applies.

The Federal Reserve Bank of New York announced Monday it has started buying mortgage backed securities (MBS), as part of its $500 billion program to improve credit market liquidity and jump-start the housing market.

The Fed said it began buying MBS guaranteed by Fannie Mae (NYSE: FNM), Freddie Mac (NYSE: FRE), and Ginnie Mae. Purchase amounts will be published on the Fed's web site beginning January 8 and will be updated each Thursday.

Goldman Sachs Asset Management (NYSE: GS), Pacific Investment Management Co., and Wellington Management Co. will manage the $500 billion in MBS the Fed expects to purchase by June.

It looks like America has shut down until 2009. And that's probably a good idea because there were so many bad ones in 2008. Bad ideas are like vampires. They charm their way into the good graces of a host society and then they suck the blood right out of them.

Although they all didn't just pop into our lives in 2008, these eight ideas reached a peak of awfulness in 2008:

• Deregulation is good. The wave of deregulation that started in the early 1980s has created enormous problems for society. Sure there were some bad regulations on the books, but just one deregulated industry -- the $62 trillion credit default swaps (CDS) market -- has cost taxpayers hundreds of billions of dollars in the bailout of American International Group (NYSE: AIG).
• If you can lend against it, securitize it. Securitization -- the practice of buying, credit-rating, and bundling loans backed by assets like mortgages, credit card receivables, and leveraged buyout loans -- created the illusion that you could mix risky loans in with safer ones and you could earn above-average returns with no risk. Bad call -- securitization has spread toxic waste around the world from Iceland to Whitefish Bay, Wis.
• Home-ownership is good for everyone. The hungry maw of securitization created enormous demand for new mortgages. And that led mortgage originators to lend to people who couldn't afford to pay back the loans. The $1.3 trillion subprime mortgage market was born and it grew so big that its collapse refused to remain contained. In 2004 Bush bragged about home ownership reaching 69.2% -- three million foreclosures later it seems we should be careful what we wish for.
• Leverage up your balance sheet 30:1 or more. In 2004, the SEC gave financial institutions (FIs) discretion to borrow more money than they had ever borrowed before. Most banks and hedge funds borrowed as much as $35 for every $1 of equity. If they had used their $340 billion in equity to buy the $13 trillion worth of mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs), a 3% decline in the MBSs and CDOs value would have wiped out the FI's capital.

What does the future look like for quasi-public mortgage service giants Fannie Mae and Freddie Mac?

More than likely, it's the conversion of each to an overt, government-based organization, so says economist Peter Dawson. Earlier this year, the U.S. Treasury purchased Fannie and Freddie for $1 billion in senior preferred stock in each company and warrants representing ownership stakes of 79.9%.

Will FNM, FRE become government agencies?

But don't run to sell or buy Fannie's (NYSE: FNM) or Freddie's (NYSE: FRE) stock just yet, Dawson carefully added. There are too many variables and unknowns regarding the health of the U.S. economy to say with a 95% confidence interval what form Fannie and Freddie will take in the Obama Administration, Dawson said.

The biggest factor in Dawson's projection that Fannie and Freddie will have to be formally aligned with federal government operations? The $5.3 trillion in mortgages that the two government service enterprises own or guarantee - - or roughly 44% of the U.S. mortgage market.

"The immediate focus of Congress is the fiscal stimulus package, and that's warranted, given the recession and the large stimulus that will be needed to get GDP headed in the correct direction again," Dawson said. "But one, major, longer-term focus has to be Fannie and Freddie. They are likely to require federal cash infusions, via buying their mortgage-backed securities, or other investments, for at least a decade, probably longer."

Banking analyst Meredith Whitney is credited with questioning assets on bank balance sheets given the collapse in the real estate market.

Taking advantage of a complete lack of information, Ms. Whitney triggered a massive collapse of trust in an industry by claiming that mortgage-backed securities were worth far less than what the market had perceived.

While she may have had a basis for her claims, her assessment was more sensational than factual. Mortgage-backed securities are quite complex instruments whereby loans are sliced, diced and packaged for sale to a global market.

With maturities extending 30 years into the future, it is unreasonable and unfair to assume that paybacks, even with high default rates will amount to what is currently priced into the market.

The lack of understanding of the underlying security or loans at the individual level has created uncertainty that has yet to be resolved.

For fans of the original "Star Wars" movie, think of the weakness in terms of attacking the Death Star. That one hole was exploited (we can debate the merits of doing so later) by Ms. Whitney and those like her.

No mainstream economist or analysts thought the United States financial system and economy would ever face circumstances like these, but fundamentals and a negative spiral have worsened to such a degree that the nation may have to implement a temporary, home mortgage foreclosure for all mortgages, according to an economist.

Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) have already announced a six-week halt to foreclosures and evictions through the holidays, lasting until January 9, to give the servicers time to implement their own program for at-risk mortgages, Bloomberg News reported. The government-sponsored enterprises own or guarantee $5.2 trillion of the $12 trillion U.S. home mortgage market.

National moratorium needed?

Economist Richard Felson told BloggingStocks a national moratorium on the remaining roughly $7 trillion in mortgages would give the incoming Obama Administration time to play-catch up, after the Bush Administration's underperformance on a universal, streamlined mortgage refinancing program. If implemented, the plan would end the rise in home foreclosures that's causing the securities defaults that are elongating the financial crisis.