October 11, 2009: Is the originate-to-securitize model dead?
Coming in at #7 on my "Top Ten Reasons for Double-Dip Recession" (see Sep. 25, 2009) is freeze-up of the securitization market. During the past two decades, securitization has increasingly enabled banks to originate more and more loans with the same amount of capital by then selling those loans to investors in the form of securities, primarily mortgage-backed securities.
One of the biggest problems facing credit markets is the apparent demise of the "originate-to-securitize" model of bank lending. During the last two decades, banks have moved away from originating loans, especially residential and commercial mortgages, to hold in their portfolios towards orginating loans to package into securities and sell to investors around the world.
This move was an "unintended consequence" of risk-based capital regulations that require less capital be held against securities than against whole loans. With no "skin in the game," banks and other lenders made hundreds of billions, if not trillions in poorly underwritten loans that blew up in 2008, imposing massive losses on investors and drying up demand for mortgage-backed securities. Of course, this required the complicity of the three major ratings agencies; without triple-A ratings, unsophisticated investors never would have purchased these securities.
Beyond government-insured issues, U.S. securitization markets essentially remain frozen. No CMBS have been issued in two years. The only player keeping residential securitization in action is the Fed, which has committed to buying up to $1.25 trillion in RMBS and already has bought more than $900 billion, accounting for about 4 of 5 mortgages securitized during 2009. Private securitization dropped from almost three-quarters of a trillion dollars in 2008 to less than 10 billion dollars in 2009.
What will happen when the Fed reaches its self-imposed cap? Most likely, one of two outcomes: either the RMBS market will come to a screeching halt, or the Fed will re-assess its cap and continue buying.
