Missing The Point

Floyd Norris piece in the NY Times over the weekend misses the point.

http://www.nytimes.com/2010/02/06/business/06secure.html

It’s not the securitization process that needs to be fixed or even reformed. It’s the process before the actual packaging.

When are we going to hammer down Banks for poor lending policies and practices?
This was the problem. The Lend-To- Package network finance model is the primary culprit for our pain. When you have whole loan desks at major Wall Street institutions that are in a bidding war for garbage paper, what do you expect?

The primary problem was the ingredients to the soup that made the soup toxic. The securitization process only magnified the problems in lending standards and that festered throughout the finance supply chain.

The only way to “fix” securitization is to educate borrowers against predatory lending. Make down payments larger. Potential home owners should show full financial documentation. All of this would be accomplished if a proper Consumer Protection Agency was established. I have been very skeptical on this issue, but my bad, I didn’t really understand it when I first read about it, and I thought it was just another lousy government agency. This is no longer the case.

Securitization just made Network Finance not take control of their risk management. If you didn’t have to hold on to the loans why make sure they are actually good loans? In this case the banks would not have to hold proper cash as reserves. The banks used securitization to increase leverage and risk throughout the channel, this was the opposite of many claims throughout the years. In turn they destabilized our economy.

Securitization worked great in the 80’s and 90’s, but starting in 1998 or so it all went to hell. This is because Greenspan and the FRB started a low interest rate era. Bernanke has just taken the baton. On top of this, they the FRB refused to regulate lenders like New Century and Cityscape Mortgage. From this millions of shoddy loans were underwritten. The whole idea of having lending standards went into the toilet. There was never proper due diligence paid for a potential homeowner to actually pay back the loan. It was all about how quickly I can underwrite and then package the loan to yield/alpha hungry investors. The whole idea of lenders qualifying borrowers was gone. The ratings agencies certainly didn’t help either. Their entire mode of existence was based on volume of securities rated. The more they rated AAA, the more business they received. Without these AAA ratings, these loans would never have been placed to mutual funds, pension funds, etc.

When I first started trading in the early 90’s, securitization was evident everywhere. Auto Loans, Credit Cards, Student Loans, Home Loans, etc were packaged, but there were some level of understanding the quality of loans being put together. There was never a problem with securitization because the underlying quality was good. Securitization has been with us a long time and it functioned quite fine, but in a very lax regulatory environment that encourages undo risk taking securitization broke down.

This is very similar to derivatives. They have a tremendous positive influence on risk management, but if you don’t properly regulate them and put them on exchanges so that there is transparency you just open yourself up for disaster.

You can’t allow human beings to shed accountability let alone liability.

Sooner or later it was bound to blow up.