The ever-incisive FT columnist Martin Wolf offers prudent and timely advice concerning the reforms needed to ease credit market doldrums and right the global financial state of things.
One key practice Wolf would like to see addressed is bank / mortgage lender selling of mortgages they originate.
Designers of the practice had good intentions: It was designed to free-up capital so banks / mortgage lenders could have more money available for future homebuyers. A noble intention.
Unfortunately, as tradition reminds us, the road to perdition (and record housing sector slumps) is paved with good intentions. The problem, Wolf notes, is that the originate-and-distribute model encouraged banks / mortgage lenders to originate (in many cases for handsome fees) high-risk, very-poor-credit-quality mortgages with reckless abandon, because originators knew that the loan would be sold, and its status as a performing asset would be entirely someone else's problem. Save the best (mortgages), get rid of the rest.
It's not surprising, Wolf notes, that the originate-and-distribute model became laden with sloppy, irresponsible and even fraudulent loans. Wolf's reform: originators must be required to retain a portion of the equity of securitized loans. Hence, if / when they go bad, the originator loses money too.
Economic Analysis: Wolf's proposed financial / bond market reform is on the mark. If every party, including the originator, has a stake in a mortgage's repayment status, that will lead to higher-quality loans, while at the same time retaining the secondary market's benefit of freeing-up capital for new mortgages.
Martin Wolf: We need a mortgage system where banks, lenders have skin in the game
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Reader Comments (Page 1 of 1)
5-07-2008 @ 6:06PM
Dan Barnett said...
What if the mortgage loans were a personal contract. i.e. not transferable? I mean not all loans are assumable by a "new" borrower, so why should a "new" lender be allowed to assume the loan?
Banks would be responsible for the loans they make.
5-07-2008 @ 8:59PM
william lindblad said...
If we started at the base and the mortgage loans were of defined risk nature we would not have the current mess. For example, if the loan package contained 20% high risk, 30 medium and 50% low risk there would not be a problem. Under normal circumstances the default factor would not exceed 10%. When you package loans that are 80-90% in the high risk category you will have problems. The real problem lies in origination and we need a different system. The banks came up with "credit score" and this would be a good method for determining both interest rate and eligibility of loan amount. Loaning money at cheap rates to people with bad track records for repayment is insanity, but that is what the banks did. Greed rules supreme and the only way around this repeating is legislation and a better financially educated public. What we have in our laps in the result of an insatiable appetite for living above ones means in the form of luxury homes. The fault lies with the people, the real estate agents, the banks and the builders. You made this bed -lie in it. You have created a monster that is so large that even the intervention of the Federal government will be unable to bail out. The final cost of this mess I estimate at between 6-8 trillion dollars and the history books will prove me correct. This cost will burden generations, that is, if the government is foolish enough. Helping those that need it is one thing, but helping those that had their eyes open and knew the consequences is another. If this is to be the way of the future than the government should help all that make bad investments period.
Buy a Chinese flag as they will own the U.S.