Friday, March 27, 2009

Securitization Did Not Fail

This morning my brother sent me the Op-Ed piece from the New York Times by Paul Krugman titled THE MARKET MYSTIQUE. I read the piece and I disagree with his conclusion. I do not know if I am allowed to disagree with an economist that won the Nobel Prize in Economics; however, since I do not know how to contact the Nobel Foundation for permission, I will proceed with my post anyway.

Professor Krugman makes the statement that “securitization failed.” Securitization did not fail. What failed was the credit ratings agencies. Remove the responsibility of rating the structured debt obligations from the private sector and put it will the Federal Government and that would go a long way to give the securitization of mortgages, car loans, etc. the kind of independent bond ratings that would make the process of securitization work. Securitization failed because the underwriters were able to shop the credit rating agencies for ratings.

In previous postings, I described in detail how the credit rating agencies permitted the bubble to grow and grow. In previous postings, I described in detail how the triple-A rated collaterized mortgage obligations found a market throughout the world. The gate keepers to this whole process of securitization were the credit rating agencies, but the men running the three largest credit rating agencies caved to the pressure from the investment bankers and instructed their people to pass out the triple-A credit rating like candy on Halloween. The CRAs were only looking out for their bottom line and felt no responsibility to the investors that used their credit ratings for guidance.

The mathematical models that were available to the credit rating agencies were not used. That does not mean that securitization failed, what failed was the Federal Government’s responsibility to give oversight to the Federally regulated credit rating agencies. Ask Senator Chuck Schumer about what hand he played in weakening their responsibilities to the investment community. That information was printed in the Sunday New York Times on December 14, 2008, yet not a word of that article was picked up and discussed on any of the news shows that week. Why?

Securitization did not fail. What failed was a financial system that regarded investors as fish to be shot in a barrel. Securitization is a financial tool, used properly it can be an important part of the of the capital markets.

Stay tuned.


winslow said...

I agree with you. It points out the problem that a renowned economist(in this case) might not know all the intricacies of this debt environment. I know in my line of work, I do consider myself an expert, yet when a new CEO came aboard, he was considered the "expert". (I found that not to be true many,many times).
What a company needs (or the country for that matter) is a leader that can decipher the expert information from all sources and make an intelligent decision. I think Obama has this capability, Bush did not. I worked for a few leaders that had this ability...but I also worked for more than a few that were....idiots.
This lack of leadership ability is sooooo apparent today. Many of our financial institutions were headed by these individuals.

As an aside, I was watching a panel debate yesterday with some top business leaders concerning excessive executive pay. The general concensus was (even though some agreed grudgingly)that the government needs to step in to regulate this outrageous pay and benefit schedule. Of course, the debate centered around capitalism and socialism. In my opinion, we cannot have individuals making 100 million+ per year while the majority are stuck at 50k. Too much power is granted to those with the most money...both in government and in business competition(if I was making the 100mil I wouldn't want any changes) but how can we have a democracy with such a great disparity.

moneythoughts said...

Winslow, good comments.

I was just trying to make the point that the financial tool, the securitization of mortgages, was not the problem. We have computers and math models that will deal with the numbers. The problem was with the lack of regulation and oversight, especially with the credit rating agencies. Had the collaterlized mortgage obligations (CMO) and other strustured debt instruments been given the correct ratings, it is my opinion, that the meltdown from these bonds would have not ocurred.

The issue of the credit default swaps, and their regulation and reserve requirements is a whole other problem. Registering hedge funds and private equity funds is a whole other issue too.