Does the Mortgage Mess Doom Securitization?

By Daniel Indiviglio

When the foreclosure crisis revealed that banks may have been sloppy with their processes and documentation, and big investors took note, one report indicated that the securitization market had begun to seize. You can imagine that if banks had been doing shoddy work putting together mortgage deals, then there could be a contagion to other asset classes as well. How much might the fiasco affect securitization?

At this time, it doesn't appear to affecting it much. If there was an initial hiccup, then it didn't persist. Two major asset-backed auto deals have been issued since last week, by Nissan and Volkswagen. Moreover, this week saw nearly $5 billion in new commercial mortgage-backed securities, according to Dow Jones Newswires. This implies that investors' fears may be isolated to residential mortgage securitization -- and they were already scared of that before.

The so called private-label mortgage-backed securities market, where the loans are not insured by the government, has failed to awaken since the financial crisis -- now more than two years later. Here are some of the big obstacle it faces:

  1. First, there was the hesitancy from investors who no longer trusted the rating agencies. As a result, they likely wanted to analyze the deals themselves, so they needed the data.
  2. Not only was the data a problem, these investors often had neither the manpower nor expertise to perform such analysis. 
  3. Next, there's the new reality that home prices can, indeed, decline. This screws up the old models and requires entirely new analysis. 
  4. Then, Congress came along and imposed some significant new regulatory requirements on the securitization industry. For example, now banks must retain a portion of the mortgages they intend to securitize. 
  5. There's also the further uncertainty clouding the market as Washington tries to iron out its new housing finance policy over the next year. 
  6. Now, the new mortgage mess has brought to light the fact that some banks and servicers were trying to limit their origination costs by skipping steps throughout the process and not hiring enough personnel to properly work through delinquencies and defaults.

And these are just some of the more significant obstacles facing the market. If you add these all together you get one obvious result: higher costs. Here's how each of the above challenges makes the process more expensive:

  1. Information will have to be provided in an easily accessible way to investors, which will cost money.
  2. Investors will need to hire additional research staff to crunch numbers as they reduce their reliance on the rating agencies. 
  3. New models will take time (and money) to develop, and the possibility of losses mean that investors will pay less for the mortgage securities, which increases the funding costs issuers face.
  4. If banks need to hold on to more risk, then securitizing becomes relatively more expensive than it used to be, since they will have to reserve for additional potential loan losses.
  5. Uncertainty is a pretty clear cost, as investors must consider the possibility that future rules affect the value of their portfolio of mortgage securities. 
  6. Additional workers to ensure that processes are correct involve cost, as will auditors that might be necessary for additional loan file due diligence that investors may demand going forward.

Somehow, private label mortgage securitization will have to endure all of this increased cost to come back. Considering that it's fairly likely that the government will insure all mortgages, however, that will get rid of items 3 and 5 above. Any additional cost, however, will ultimately be passed on to borrowers in the form of higher interest rates or fees on mortgages. But if those interest rates grow too high to where renting becomes clearly more attractive to more Americans, then homeownership and securitization volume will decline.

This article available online at:

http://www.theatlantic.com/business/archive/2010/10/does-the-mortgage-mess-doom-securitization/65230/