How Can Securitization Lending Be Made Safer ?

Dinner Guest: How can we all have died at the same time?
Grim Reaper:  The Salmon Mousse!
Host: Darling, you didn’t use canned salmon, did you?
Wife: I am most dreadfully embarrased~!

Monty Python’s The Meaning of Life Part VII: Death


In his column today, Floyd Norris asks “Can the world be made safe for the return of securitizations?”

To a degree, that is the wrong question.

While some people have become focused on securitization, what we should really be looking at is the step prior in the process — the actual underwriting standards of the mortgage loans that were bundled and resold. It was the abdication of lending standards by the “lend-to-sell-to securitizers” business model that caused so much of the trouble (yes, there were subsequent errors, but they came after the lending standard failures).

Were the the dinner guests in the Monty Python film killed by whipping ingredients in a food processor until they were creamy smooth? That is a similar question to the issue of securitization — the primary problem was not the process, but rather, the ingriedients that went into the process.

The securitization process simply amplified the poisonous underwriting, and fed it to the world. Canned Salmon — Garbage In, Garbage Out.

The way to fix securitization is to fix lending in general — develop standards, enforce them, educate borrowers, halt predatory lending.

Back to Norris:

“Can the world be made safe for the return of securitizations?

That is a question of great importance to those like John C. Dugan, the comptroller of the currency, who say they believe that the banking system on its own is unlikely to have the ability to provide enough credit to sustain an economic recovery in the United States.

“We need a vibrant, credible securitization market to help fund the real economy going forward,” Mr. Dugan said this week. He was preaching to the choir — a meeting of the American Securitization Forum — but it is an opinion widely held in financial markets.

It is possible to question that thesis. Securitization grew as a way for banks to get around capital rules, not because of any profound desire by investors for such assets or any real unwillingness by banks to make the loans. But since it was more expensive to hold capital against the risk if the loans were not securitized, they were securitized. That also opened the market to new players, who neither wanted to, nor could amass, the capital to hold onto loans.”

It wasn’t that the non-bank lenders could not amass the capitasl — that wasn’t their business model. Instead, their inventory was cash, and the greater they turned over their inventory, the more profits they made.

That is, until they went bankrupt. As of the most recent count by mortgage imploder, ~ of these lenders have gone belly up

Norris concludes:

“There are several essential elements to any fix. The underlying loans have to be of better quality. The investors have to believe that is the case and that they are being compensated for risks that were much higher than they previously believed. Another 30 percent collapse in home prices is unlikely, but it will be a while before anyone’s models deem such a thing impossible.”

That seems about right . . .


Paul Krugman is Wrong About Securitization (March 28th, 2009)

Seeking a Safer Way to Securitization
NYT, February 5, 2010

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