Time to Re-think Securitization?
By Arnold Kling
On Wall Street and in bank boardrooms, the question of whether investors can force banks to buy back, or “put-back,” the bad mortgages to the banks that sold them is dominating the debate and worrying analysts, money managers and banking executives.
The story says that the Federal Reserve, which now owns a lot of mortgage securities, may be joining the put-back crowd.
When mortgage lenders sell loans to Freddie Mac and Fannie Mae, they make “reps and warrants” (representations and warrants) that the loans comply with rules and guidelines. If a loan is later found not to be in compliance, the lender is required to buy it back.
This is just one of the many mechanisms within the securitization process that are designed to address the principal-agent problem. We are seeing evidence of this problem everywhere, including in the foreclosure mess.
Since the financial crisis began, I have been inclined to think that we need to go back to traditional mortgage lending and stop trying to use government policy to sustain the securitization model. Each month, the principal-agent costs seem to mount, adding to the disadvantage of securitization.
To me, it is obvious that the overall costs of the securitization model are high relative to the costs of traditional lending. But what is obvious to me is unthinkable in the two places that matter–Wall Street and Washington.