Commentary on Securitization: ASF and NERA Rearrange the Deck Chairs

My friend David Grais has started a blog devoted to structured finance and the law.  David is a very skilled litigator who spent most of his career doing corporate defense work, but has defected from the Dark Side to become a plaintiff lawyer working on a number of very important ABS cases.

David just posted a comment on the his firm’s blog [] that has some interesting insights about the Obama Administration’s plans for “reforming” the securitization markets.  His comment follows below.  — Chris

Proving yet again that it has become a puppet of its sell-side parent SIFMA, the American Securitization Forum has just released a 241-page study that it commissioned from National Economic Research Associates, Inc. (here) to prove that securitization increases the amount and lowers the cost of consumer credit. It is as though the White Star Line commissioned a book on the RMS Titanic in which the author was told to extol the power of Titanic’s engines, the elegance of the china in its dining rooms, and the verve of its dance bands, while strictly ignoring its shortage of lifeboats.

There is only one question worth asking about securitization: why did securitization become the seedbed of the broadest and costliest epidemic of fraud in history? Until we face that question squarely and answer it honestly, securitization will remain in its coma. Unfortunately, the Obama Administration missed a chance to address that question in its plan to regulate the securitization market. (See the post immediately below.) ASF’s sponsorship of the NERA report is more insidious. By a combination of forbidding mathematics and emollient prose (“Recent experience appears to demonstrate readily that securitization is not inherently ‘good’ or ‘bad.’”), ASF tries to whisk us past that looming question and past the one measure that will best restore confidence in securitization: effective redress for investors against those that turned securitization from a useful financial tool into an orgy of misconduct.

ASF’s ill motive and Orwellian methods are evident from its own paper (here), in which it announced the NERA study. ASF says that it commissioned the study in the fall of 2007, when “securitization markets were robust, with continuing growth and strong issuance volumes in major asset classes.” Its motivation, says ASF, was its “assessment that … there was surprisingly little academic or other research that attempted to evaluate and quantify the broader economic impact of securitization in an analytically rigorous way. By selecting NERA … ASF hoped to close this gap in part, and to make a meaningful contribution to the industry and academic literature.”

Does ASF really expect anyone to believe this? In the fall of 2007, securitization was in free fall, as the nearby graph of RMBS issuance in that year shows. And since when was the trade association of the securities industry concerned “to make a meaningful contribution to … academic literature”? And was it a coincidence that ASF commissioned the study from NERA, a subsidiary of Marsh & McLennan known mainly for its work defending suits for securities fraud?

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The NERA study itself is a prodigious work by two fine economists. But the study inevitably reflects ASF’s instruction to focus on china and music and to ignore lifeboats and icebergs. The study may be right that securitization has lowered the cost and increased the amount of consumer credit. But in subprime and Alt-A mortgages in 2005-2007, securitization did so by obscuring the risks of those mortgages and thereby inducing investors to pay far too much for bonds backed by them. Thus, in its most important arena of RMBS, securitization did not lower the cost of credit; rather, it obscured that cost and then shifted it to investors. The results, of course, were a massive mispricing of risk and misallocation of resources that have shaken the financial system to its core.

If ASF could free itself of the big banks that dominate SIFMA, then it could make a useful contribution to reviving securitization. Until it frees itself, ASF will remain a puppet of the legal and public-relations departments of those banks, as its sponsorship of the NERA study shows.

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