Level the Playing Field: Business Securities and Investors vs. Mortgage Securities and Borrowers
It was nice last week to be included as a signer of a letter organized by Chris Whalen to the Secretary of the Treasury, the Comptroller of the Currency, the Chairmen of the SEC, FDIC, Federal Reserve, and the Acting Director of the FHFA about improving the mortgage market. You can read the letter several places on the web, including Nouriel Roubini’s site.
The letter calls for “national standards for originating, selling and servicing mortgage loans” because the “private residential mortgage securitization market is frozen as to new issuance.” We’ve long had national standards for originating, selling, and servicing investment securities for business financing. Solid accounting standards, open and transparent stock exchanges, and effective business securities regulation give us the world’s strongest capital markets — in no small part thanks to national standards biased toward openness and transparency.
The disparity in regulation between the origination, selling, and servicing process for business investments (at least for public companies) and the origination, selling, and servicing process for mortgages was a form of regulatory bias that resulted in too much leveraged retail investment in real property mortgages at the expense of both retail and professional investment in business. True enough: Mortgages are an important source of funding for new business start-ups and business capital. That’s all well and good as long as lender and borrow enter the transaction with healthy understandings of the risk/reward balance. But in the case of mortgages, the buyers of these products, i.e. both the borrowers who paid interest for the rights to immediate cash in exchange for making a future stream of payments, and the buyers and sellers of the rights to these streams of payments from securitizers, were the victims of a dysfunctional information ecosystem.
Moreover, many of the securitizers themselves were simply victims of a human nature that tends to prevent one from seeing flaws in things that earn you money. (Yet another advantage of the rigor of the business investment securities system is that government-mandated GAAP accounting tends to force all but the occasional Enron and WorldCom executive back toward reality.)
Notwithstanding a recent spate of anti-market, pro-substantive regulation books on the financial crisis, it was not a lack of substantive market regulation that let the bubble in mortgage backed securities grow as large as it did. There was plenty of regulation. It was just bad regulation. The bubble grew because the regulatory system allowed rampant information asymmetry and just plain ignorance in the world of mortgage backed securities — a world in which many participants thought they were too special for meaningful audited financial disclosures, open auction-based pricing, and the ready availability of information that effective free markets require.
Mortgages, like public company securities, can be viewed as investments of money with the hope of profit. With off-the-shelf technology to protect borrower privacy while disclosing timely and meaningful data, bundles of mortgage securities could be traded on exchanges just as easily as public company securities. The question remains whether it is possible to overcome those who still to this day to profit from opacity in the now largely-nationalized mortgage security market. The latest stories on the GOP focusing on gradualism instead of transparency aren’t harbingers of hope.
