Marketplace Scratch Pad

Bundle ’em up again?

Scott Jagow Jan 25, 2010

The FDIC is expecting more bank failures this year, in large part due to bad commercial real estate loans. It can be very difficult to find a buyer for a bank loaded down with toxic assets. But if you take pieces of loans across many banks and wrap them up with care, you might be onto something.

We’re working on a story that says the FDIC is in the early stages of a plan to repackage billions of dollars in mortgage assets into securities. Reportedly the FDIC might sell these securities with US government backing, thus ensuring a AAA credit rating.

Careful now, don’t spit up your drink. Yes, one of the causes of the financial crisis was that the credit ratings agencies slapped AAA ratings on bundles of garbage loans. But when done properly, securitization can be quite effective. The underwriting standards must be stringent, the bundles must be diversified, and they should be first generation, meaning none of this derivative stuff spun off into a million pieces.

Bair has actually been beating this drum for a while now. Consider these comments from the Housing Wire:

A more transparent securitization process is the solution for the pain still felt in the financial markets, according to her comments, made Thursday before the Financial Crisis Inquiry Commission.

Credit-rating agencies (CRAs) are often assigned blame for giving structured finance vehicles high ratings despite significant risk in underlying mortgage products…

Although CRAs sometimes assigned triple-A ratings to residential mortgage-backed securities (RMBS) that would eventually be slashed in the midst of massive subprime-related defaults, CRAs are not the only party Bair held responsible in her comments.

She recommended both originators and securitizers retain some form of recourse to ensure sound underwriting for future structured finance transaction. And consumers should understand financial products offered to them as well as demonstrate an ability to repay.

In other words, lenders, borrowers, securitiziers and rating agencies all need to do a better job of making these securities more sound. If that can be accomplished, these government-backed securities could be very appealing to buyers, giving the FDIC a new source for replenishing its bank insurance fund, which is in the red for the first time in two decades.

On the other hand, if the securitization is sloppy or if commercial real estate blows up much worse than expected, the FDIC could face major problems. Can you imagine if some of the healthier banks bought the securities and then went bust because of them?

The FDIC would be left holding the same garbage bag all over again.

But in general, do you like the idea?

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