Tuesday, April 1, 2008
Fixing the Mortgage Market
"But it is certainly not the time to overreact and undermine the most fundamental aspects of our free-market system. And we need rewards for winners and penalites for losers. ... Securitization is not the cause of the massive problems in our credit markets. The problems are due to basic mistakes that even the most unsophisticated among us can grasp. Lenders loaned too much money on too easy terms to borrowers who did not have the capacity to make their payments. No alchemy by even the brightest minds on Wall Street could turn bad loans into good assets. Sound simple? It really is. ... One common fix advocated is to abandon or de-emphasize mark-to-market accounting in favor of allowing companies to estimate an assets 'true' long-term value. Another is to move away from securitization and return to a portfolio lending model--where, for example, the bank originating a mortgage keeps it (in its own portfolio of assets), rather than selling it to a third party (as in securitization). Both fixes are tempting. Both are mistaken. ... The argument in favor of portfolio lending is based on the notion that, unlike securitization, portfolio lending incorporates the discipline of 'skin in the game.' Since, in the portfolio lending model, the loan's risk is not being transferred from the originator/lender, underwriters will therefore be more careful. ... And for price discovery to happen, the government needs to get out of the way, encourage transparency, and let the market resolve this crisis. ... Let us not forget that the only value of an asset is what someone will pay for it, not some theoretical value derived from a complex computer model. ... Pehaps the issuers of these bonds [mortgage related] will have to retain a portion of the securities, i.e., 'skin in the game.' The rating agencies have already made numerous modifications to their model, and are highly motivated to self-police", my emphasis, Ethan Penner (EP) at the WSJ, 25 March 2008.
I am in partial agreement with EP, believing "skin in the game" is as necessary for a mortgage originator as a borrower. I disagree with his conclusion about the rating agencies, i.e., their efforts at self-policing are as pathetic as the CPA profession's. Ann Rutledge, it really is that simple. It's so simple, even I can understand it. EP was CEO of Nomura Capital.