Securitization of Mortgages

Reflecting upon securitization of mortgages: It has seemed that one of the hallmarks of banking has been knowing one's customer, being able to work with him or her to encourage success or limit losses. Securitization, where mortgages are bundled and sold to third parties, eliminates this potentially enabling relationship.

So where is any value created in securitization? Perhaps there is a little in expanding the markets for debt, but it would seem this could be accomplished by sales of whole loans. And any enhanced market liquidity would seem more than offset by (a) the utter opaqueness of the securities (i.e., the inability to predict the likelihood of default by individual borrowers) and (b) the complexity involved in working with borrowers in the event of default.

The real "value" of securitization appears to be in throwing the bundled instruments into the realm of the credit rating agencies, substituting their second-hand, generalized, and dubious analyses and opinions for those of the original lenders.

Of course this doesn't create any real value whatsoever, but just an impression of value. Indeed enough credibility during the late financial boom to permit both originators and bundlers to extract substantial fees before the credit rating agencies were discredited and the emperor's nakedness was exposed.

It's hard to see a role for such instruments in a stable financial future.

Refinancing One's Home

I saw an article in the news this week of an unfortunate woman who had lost her home after refinancing. She had apparently been unable to make the payments on the refinancing loan.

It is remarkable how many people seem to think that once a home has appreciated in value, the increased equity is somehow the equivalent of free money. It isn't. As long as the owner lives in the home, he or she is using the appreciation. To both live in the home and borrow against the equity is to use the appreciation twice, and the second use is an additional burden that must be repaid, usually beginning right away in the form of monthly payments. The home equity loan is a burden just as a personal loan of a similar amount and terms would be if the property had not appreciated. Indeed the appreciation tends to make homeowners more giddy and banks more accommodating, so home equity loans are likely to be larger and thus more burdensome than unsecured personal loans. And of course it's easier for the homeowner to lose the house in case of default.

Reducing the Principal of Underwater Home Mortgages

I see today in a widely respected newspaper an editorial referring to home mortgages, calling for "reducing principal balances for millions of people who owe more on their homes than they are worth." That would likely require hundreds of billions of dollars. Who, pray tell, should pay for this program? The banks, whom we've just bailed out? The taxpayers themselves, who are already incurring record deficits? Should principal reductions apply irrespective of the size or value of the home or its suitability for the owner's circumstances? Should it be public policy of this nation to protect people from the unfortunate circumstance of a decline in the value of their property? Where might this lead? Should it be an ongoing policy, or just a one-time thing? Should we consider additional reductions if the property value keeps falling? Should it apply to personal property as well as real estate? Should it be extended to include circumstances in which the property was overvalued and thus in a deficit position when the property was initially encumbered? And who is to make the determination as to what the value of the property is? Wouldn't it be more prudent to encourage people who can't afford to hold on to their homes to trade down or rent until their circumstances vis-a-vis the market improve?