Why are banks allowed to resell mortgages? It just seems like a way to get around money creation limits imposed by liquidity requirements. For example if a bank creates new money by extending new morgages then securitizes them and resells them, the bank is effectively printing money and giving it to itself to boost it's liquidity ratio, which in turn allows the bank to extend more morgages and resell them ad infinitum!

Maybe it's actually good that banks can do this? I'd like to know if this is a responsible business practice that's good for the economy as a whole (maybe allowing for cheaper mortgages) or if it's only in the interest of bank shareholders (at the expense of destabilizing the economy).
A bank selling mortgages does not, by itself, increase the money supply.

To see this, work through the balance sheet implications step-by-step:


A bank makes a mortgage loan, swapping cash assets on its balance sheet for a mortgage asset. The customer receives cash. At this stage, the money supply has been increased.


2a. A bank sells a mortgage to another bank, swapping cash and mortgage assets between the two, but without increasing the money supply.

2b. A bank sells a mortgage to something that is not a bank, reversing what it did when it made the mortgage loan: the bank ends up with a cash asset and loses the mortgage asset, while the not-a-bank entity loses cash, decreasing the money supply.

They key here is that expansions or contractions of the money supply arising out of banking have everything to do with the the extent to which banks in the aggregate are lending cash that has been deposited with them (i.e., deposit liabilities). It’s a stock, not a flow, so you have to analyze the balance sheet impacts of what happens when banks sell an asset, paying attention to how the buyer is financing the purchase, to understand what the effect on the money supply is.

The (glaring) exception to this is that many entities that hold mortgages act effectively like banks, but aren’t banks. They’re often referred to as “shadow banks.” There are a lot of different types of entities that do this, but a simple, clean example is a mortgage REIT. If a REIT buys a mortgage security, it will likely fund it by doing a repo (basically borrowing money but with collateral) with a money market mutual fund, which is lending out its depositors’ money, just like a bank.

One note: In responding, I’m deliberately ignoring the part about liquidity requirements, because money creation by banks can be (and has historically been) bound at different times and for different entities by liquidity, capital, or reserve requirements, but liquidity requirements in the US are not generally intended to constrain money creation per se, but rather as a prudential measure. More specifically, GSE MBS is a Level 1 “high-quality liquid asset” under the liquidity coverage ratio, so swapping mortgages once they’ve received a GSE wrap doesn’t actually do anything to improve a bank’s liquidity ratio.