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The Death of Securitized Mortgages

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In yet another example of synchronicity, Jim Hamilton provides a chart from Peter Hooper that illustrates why the housing market is in the doldrums: securitized credit has all but vanished. This topic came up in the previous post as a explanation of why the real estate market is coming to look like a war zone.

The collapse of private sector mortgage securitization hasn’t gotten the attention it deserves. To put it in crude terms, securitization became central to how we finance housing in America. Banks held only a small portion of the loans they originated; the rest were sold. As we have discussed elsewhere, securitization depends on credit enhancement. Paul Jackson reported early this year that the revival of securitization depended on having support of some form:

While the monoline business may or may not be less important in the municipal bond markets due to the unbelievably low incidence of defaults, the guaranty business is actually far more important to the MBS business than most have given attention to thus far — precisely because defaults can and do happen.

For secondary mortgage market participants, resolving this crisis isn’t just a piece of the puzzle; it might be the puzzle. At the American Securitization Conference in Las Vegas last week, many investment bankers suggested on panels and in hallways that the bond insurer mess is the single largest issue keeping the private-party market from having a chance at establishing any modicum of recovery going forward.

In fact, regulators do not expect securitization to return to anything like its former level. They expect far more bank originated assets to stay within the banking system, on their balance sheets. That in turn will require them to carry vastly more equity than they do now. It will take financial institutions some time and doing simply to secure enough equity to make up for losses and increase their capital levels to the new more conservative standards that are being implemented.

The impairment of lending capacity suggests that housing prices could overshoot their “fair” value in relationship to incomes. Expect more efforts to socialize the housing market to prevent this outcome

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6 comments

  1. Been there

    “The impairment of lending capacity suggests that housing prices could overshoot their “fair” value in relationship to incomes. Expect more efforts to socialize the housing market to prevent this outcome.”

    It seems you mean that it will overshoot the relationship in a downward direction as house prices continue to fall.

    “In fact, regulators do not expect securitization to return to anything like its former level. They expect far more bank originated assets to stay within the banking system, on their balance sheets”

    Yes and no. Agreed the securitization business probably won’t be able to return to it previous level. But when in comes back, it will probably be due a entirely new group of large securitization players.

    The securitization business was able to achieve those levels of the past 3 to 4 years only through subtrifuge- muzzeling of the due diligence firms, failure on the part of the ratings agencies, etc. Because of the misrepresentations of risk that were imbedded in the securitization process industry-wide, the over-rated instruments that were created, were able to generate a level of investor interest way beyond what was reasonable.

    Moving forward, if the securitaztion process picks back up, it will be a simpler more transparent(i.e. commoditized) process. The gross profit margins will be smaller, so the most effective players will those that are most efficient. A low margin/high volume business model isn’t where the IB’s want to be in 5 years. Many smaller banks won’t have the scale to compete. Look for new large regional and national players to emerge.

  2. Zippy in Annapolis

    “Been there” has it exactly right. The average voter hasn’t a clue.

    Taking illiquid assets and making them liquid via securitization is one of the essential drivers in our modern economy. Until we restart that process the entire economy will suffer as commercial banks have shrinking capital reserves and the credit crunch is just beginning throughout the real economy.

  3. Anonymous

    The proof against your arguement is in the chart you yourself posted. Take a look and you will see that the past few years were bubble years in terms of non-agency mortgage securitization. The housing market worked fine before the non-agency market got so big and it can work fine after it is gone.

  4. Anonymous

    The truth is those securities are impossible to value. By the time the dust settles, your pension fund won’t be able to own them. There weren’t buyers for these things in the first place, which is why the issuers had to house them in SIVs.Finally, how does Joun Dugan still have his job? I want to know why he approved a special request to create SIVs and then didn’t track them.

  5. Anonymous

    “Expect more efforts to socialize the housing market to prevent this outcome”

    Watch closely for GNMA quarterly volumes and you’ll see that a socialized housing market crept up last quarter and is at the foot of your bed waiting for you to wake up… Should be up 73% quarter over quarter.

  6. Anonymous

    You should do a second chart because this chart is misleading. You switched from years to quarters. A more dramatic chart would emerge if you added all 2007 together.

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