SEC Wants Securitization Made Easy

The Securities and Exchange Commission has been assailed over the past few years for its failures. It didn't catch the deep problems at some of the investment banks that collapsed. It also missed a few instances of significant fraud, most notably Bernie Madoff's Ponzi scheme. But when the agency does get something right, it deserves credit. One part of its proposed rules for securitization (.pdf) is particularly smart: the SEC suggests requiring issuers to disclose an open source computer program that models each new asset- or mortgage-backed security. This is a great idea.

This computer program would essentially provide certainty to investors about how a deal works and make it easier to evaluate. Some of these deals can be very complicated, and sometimes how the bond payments would work is not crystal clear. But this computer program would make deals more transparent. There won't be any debate about how to create the model through which the assets would pass through to produce cash flows for the asset-backed bonds.

Why It's Good

There are several reasons why this is such a good idea:

Greater Transparency

First of all, supplying a computer model for investors to evaluate a deal would provide much greater transparency. As mentioned, they wouldn't need to wonder if they were interpreting the prospectus correctly. Any complaints that banks were purposely trying to create overly complex structures to mislead investors would be eliminated. There could be no confusion about how the deal works.

Keep Complexity In Check

On that note, banks would have an incentive to keep deals relatively simple. There really should never be a deal created that can't be modeled through a computer program -- because then you wouldn't be able to price it in the first place. But this proposal would ensure that no such deal could ever exist, because the proof that it can be modeled must be provided.

A More Efficient Market

If investors are provided a computer program as suggested, then the market would be more efficient. Now investors wouldn't have to take the time or spend the money to model these deals themselves, but could just feed their assumptions into the software provided by the issuer and create various scenarios. This means that a deal can be executed quickly.

Reduces Reliance on Rating Agencies

Finally, the rating agencies' role would be muted. Sure, they might still assign ratings, but if each investor -- no matter how big, small, or sophisticated -- could easily see how the deal would perform under various economic shocks, then it could use its own analysis as its primary reason for buying a bond. It would no longer need to use the rating agency's analysis as a crutch.

Potential Objections

Of course, no idea is perfect. And some issuers aren't thrilled with this proposal. Here are some objections:

A Burden on the Banks

Ultimately, the quant guys at the investment banks -- not the issuers -- do most of the heavy lifting to create these computer models. As a result, some may complain that this creates a heavy burden in terms of needing to allocate additional resources to create a computer program. This is, no doubt, true. But this extra work can (and would) just be built into the fee structure of the deal. After all, if this is what the industry needs to provide greater transparency, then that additional fee helps to more accurately reflect the true cost of issuing complex securities.

Presented by

Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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