He correctly emphasizes the role of the "Recourse Rule" promulgated by U.S. regulators in 1982.
The FDIC, the Fed, the Comptroller of the Currency, and the Office of Thrift Supervision issued an amendment to Basel I, the Recourse Rule, that extended the accord's risk differentiations to asset-backed securities (ABS): bonds backed by credit card debt, or car loans — or mortgages — required a mere 2 percent capital cushion, as long as these bonds were rated AA or AAA or were issued by a government-sponsored enterprise (GSE), such as Fannie or Freddie.
With commercial loans requiring 10 percent capital, and ordinary mortgage loans requiring 5 percent, this special 2 percent exception for mortgage backed securities with a AA or AAA rating explains why banks ended up with large quantities of mortgage backed securities.
As for the rest of the world, Basel II adopted the clever U.S. approach of treating mortgage backed securities as nearly risk free, and then formed the basis of banking regulation in the rest of the world as well.
By steering banks' leverage into mortgage-backed securities, Basel I, the Recourse Rule, and Basel II encouraged banks to overinvest in housing at a time when an unprecedented nationwide housing bubble was getting underway, due in part to the Recourse Rule itself — which took effect on January 1, 2002: not coincidentally, just at the start of the housing boom. The Rule created a huge artificial demand for mortgage-backed bonds, each of which required thousands of mortgages as collateral. Commercial banks duly met this demand by lowering their lending standards. When many of the same banks traded their mortgages for mortgage-backed bonds to gain "capital relief," they thought they were offloading the riskiest mortgages by buying only triple-A-rated slices of the resulting mortgage pools.
Of course, since they were rated AA or AAA, they were especially safe. We know this because the three SEC approved ratings agencies, S&P, Moody's and Fitch, would never underestimate the risk in an entire class of securities. They would never assume that housing prices can never fall. Right?