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October 23, 2007
The subprime mess and securitization
One of the projects I am working on is the monetization of intangible assets -- essentially, how can companies (and individuals) raise capital based on their intangibles. Part of the process is looking at the securitization of certain intangibles, specifically trade names/brands and patents. With the recent fiasco in the subprime mortgage market, the entire process of securitization has been under scrutiny. Rating agencies actions on these mortgage backed bonds are being questioned and as is the process of trying to divide up the risk of these bonds into tranches (a mechanism that appears to have failed miserably as a risk reduction technique).
Now, there is a new twist in the attempts to police the securitization process -- the assignment of liability. One of the concerns raised by the mortgage process is the lack of accountability for abuses. The securitization process removes the actions of the loan originators from any negative consequences. They collect their fee and someone else holds the loan. So there is no market incentive for the originators to avoid pushing too risky loans on consumers who are ill-equipped to handle them.
Likewise the securitizer is not necessarily accountable for the failure of the loans, since they just package the loans and sell them to investors. There is a market risk -- the securitizers can and have gone bankrupt as the value of their portfolios evaporates. But the securitizers do not have a strong incentive to scrutinize the original loans as long as they are given an investment grade rating.
Yesterday, three Congressmen, including House Financial Services Committee Chairman Barney Franks introduced mortgage lending reform legislation to tighten up standards and practices. That bill includes a provision to assign limited liability to loan assignees, including securitizers, for rescission of the loan and the consumer’s costs. Now, this liability is very targeted. Here is the important kicker: it only applies if the loans do not meet certain standards. And it does not apply to pools of loans.
As such, the provision will not provide a great incentive for securitizers to increase their analysis of individual loans. It will provide an incentive for the adoption of the mortgage standards called for in the legislation. After all, why expose yourself to additional liability when you can easily avoid it by only dealing with loans which conform to the standards.
The debate over the use of liability to encourage the adoption of mortgage standards -- and over the standards themselves -- will be very instructive for the issue of intangible monetization. One of the barriers to monetization of intangibles has been their one-off nature. Each deal is almost unique. There is little standardization. How standards might be created and enforced in this area is likely to take a cue from what happens in the much larger mortgage-back asset market.
UPDATE: This morning's papers have the beginnings of the debate. See Bill Allowing Mortgage Lawsuits Expected to Stir Fierce Opposition - New York Times, Finance Panel's Chairman Seeks Overhaul of Mortgage Regulations - WSJ.com, Proposed mortgage rules face hurdles - Los Angeles Times, and Bill Would Tighten Mortgage Standards - washingtonpost.com.
The Wall Street Journal piece spoke directly to the liability issue:
The issue of assignee liability will likely be one of the more controversial aspects of the legislation. Federal Reserve Chairman Ben Bernanke has said limited and clearly defined assignee liability could prove beneficial, but Treasury Secretary Henry Paulson has said assignee liability could scare away investors.
The Washington Post story had a critique from the other side:
[Mike] Calhoun [President of the Center for Responsible Lending] also said the bill does not go far enough in holding the secondary market liable for loans gone bad. Investors failed to correct abuses and in some cases actively supported them, he said. It's unclear if the provision that allows borrowers to sue is enough to help borrowers who are wronged. "Will it simply become the cost of doing business?" he asked.
The House Financial Services Committee will hold a hearing tomorrow (Wed) on Legislative Proposals on Reforming Mortgage Practices
Posted by Ken Jarboe at October 23, 2007 7:57 AM
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