Comments on: Do the Treasury Proposals on Securitization Reform Go Far Enough?

By: Mark

Mark — Wed, 17 Jun 2009 01:06:54 +0000

ANON: "Securitization is modern finance's greatest invention. It creates credit and liquidity..."

Securitization is an OK idea at best, but the quote may be correct. Regardless, securitization will probably remain in a slump for a while. Arguably, modern finance has done more harm than good.

The other points are amazingly ignorant -- they focus on side problems and are wrong. There are too many to criticize, but one good one is making banks responsible for crappy loans. If we did this, banks would have no incentive to securitize.

Anonymous Jones and several others make good points about a handful of securitization's many weaknesses.

By: jerrydenim

jerrydenim — Tue, 16 Jun 2009 19:23:11 +0000

ANON: "Securitization is modern finance's greatest invention. It creates credit and liquidity..."

Please explain why this credit and liquidity is so awesome if it just leads to an asset bubble? What was so bad about the old classic model?

Profit = make a worthwhile loan to a credit worthy entity, recoup interest plus principle. Vs. Profit= make stupid loan to uncredit-worthy individual for overpriced asset, sell loan to some other sucker, make 10 more bad loans.

Decoupling credit risk from lending can never result in a good outcome. I do agree people should quit complicating things, ban securitization altogether and be done with it. It serves no useful purpose.

By: Anonymous Jones

Anonymous Jones — Tue, 16 Jun 2009 16:23:55 +0000

Parkman beat me to the punch. Securitization's benefits are mostly theoretical at this point. There is no proof that the transactions costs, information asymmetry, and agency problems are outweighed by the supposed cost benefits of avoiding bank regulations and FDIC premiums. This is classic economics (theory trumps reality) by ignoring transactions costs. Yes, securitization sounds terrific in theory. I was enthralled with the idea a decade ago. I'm back to reserving judgment for now.

By: tj

tj — Tue, 16 Jun 2009 14:17:13 +0000

as is often the case with regulatory reform, these ideas miss the big point: no one (other than the governement) wants to buy securitized bonds.
lots of people would seel the bonds with these or other rules - gain on sale was not used by many securitizers - and this had no real impact.
with the credibility of the rating agencies completely destroyed, and the ability to price and understand risk undermined, why would anybody invest in the bonds?

how can the appropriate level of risk be determined? what is the right price for a pool of MBS?
no one knows and no one has proposed a method for determining it.
as a result, there is only one real buyer - the fed.
as a 20 year participant in this market, i don't see securitization ever coming back. if it is going to, it will need a real system of evaluating and pricing the risk in the bonds so they can be understood and traded. this is unlikely to come from the government and, as far as i can see, it is unlikely to come from the rating agencies.

By: redst8r

redst8r — Tue, 16 Jun 2009 13:43:57 +0000

@Anon: agree with your "fixes" for securitization. Wrap them up and voila' we have on-balance sheet lending.

Agree also with all prior comments that cheaper lending was due to mis-priced risk as well as greater leverage of given capital.

The effort to regulate away the problem is different only in the party being held responsible. Instead of AIG's CDS we'll have the regulators (sure to fail) promises.

Honest, they are from the government and they are here to help us.

By: Voislav

Voislav — Tue, 16 Jun 2009 12:48:03 +0000

I have to agree with pakman here. It's retarded to say that abandoning securitization will increase the cost of lending. The only reason lending was so cheap was that there was a sucker (read AIG) willing to insure these things at ridiculous discounts and relieve banks of responsibility of holding sufficient reserves to cover this.
If AIG was forced to hold reserves to cover potential losses, derivatives wouldn't have been so cheap and there would be no mess. One of or another someone will have to be forced to retain sufficient reserves to cover potential losses, whether it's the banks, insurer or the exchange (if it's created). When this is rammed down their throats, guess what, conventional suddenly doesn't look so bad, since it cuts out the insurer/exchange middleman.

By: RTD

RTD — Tue, 16 Jun 2009 12:00:53 +0000

Forcing the originators to hold 5% of the securitized product accomplishes nothing. The big shock last fall was when the market discovered how much of the securitized products were still held on the IB's balance sheets; people thought all the risk had been offloaded but it hadn't been.

I agree with the above posters about bond insurance (and insurance-like derivatives in general) and the underpricing of risk. The two are intimately related. The interest rate/return of an investment is supposed to account for risk. The use of bond insurance and CDS distorts this mechanism. It also concentrates risk in entities that are unlikely to be able to pay claims in the event of a systemic event, thus making the whole thing one big false sense of security.

--RueTheDay

By: pakman

pakman — Tue, 16 Jun 2009 11:43:01 +0000

The reason why pre 2007 securitization lending was cheaper and hence more 'competitive' than traditional lending, is not because they have less cost ie, simple metrics like FICO scores...

BUT BECAUSE THEY SIMPLY MISPRICED THE RISK.

So simple why securitization is not coming back, all the metrics used to lower costs such as FICO, Credit ratings etc... Have now proven less reliable than the model suggests...

Hence the information assymetry cost is so high as to render securitization as a whole uncompetitive.

We here in Hong Kong (no bank failures so far) still has bankers hitting the pavement, going to factories, looking at buildings etc to vet borrowers.

a banker's gut instinct vs a quant's model...

By: Sergei

Sergei — Tue, 16 Jun 2009 10:37:37 +0000

I think another reason securitisation was cheaper than bank lending, in addition to the saving of return on equity and FDIC insurance premium, was underpricing of risk. The risks of loss turned out to be much bigger than assumed, which was not priced into both senior and mezzanine tranches, and investors were not compensated for taking such risks.

By: anon

anon — Tue, 16 Jun 2009 10:36:27 +0000

This always baffles me; saying securitizations are a problem is like blaming the car for an accident when someone was either drunk or not paying attention. Securitization is modern finance's greatest invention. It creates credit and liquidity by getting the right investor the right instrument. Reform shouldn't take much thought:

a) make the underwriting bank unindenifiable for their underwritings down to the mortgage or loan broker. Meaning, you put crap in the portfolio and it defaults, you get sued and you pay.

b) limit leverage on securitized pieces such much like Reg-T. Don't sell someone a Z tranche which was underwritten like crap and sell it to a fund with 40x leverage.

c) make bond insurance illegal. It doesnt work and it gives issuers and buyers a false sense of security.

d) make CDS allowable only by those who hold the asset to be insured.

e) make all CDO's hybrid with the premium only reinvested in higher credit securities.

That's all - financial market fixed. Stop complicating things people.