The Future Of Securitization in the Age of Frustration

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 |  Includes: FMCC, FNMA
by: Ira Artman

In the 21st century asset securitization undergoes a change of phase. It broadens out and unifies. It ceases to be a tangle and becomes plainly one story. There is a complete confluence of corporate destinies. A vision of previously unsuspected possibilities brings an immense readjustment of ideas.

After H.G. Wells, The Shape of Things To Come, 1933.

Below are my future imperfect predictions.

1. Fannie (FNM) and Freddie (FRE) will be merged & their retained portfolio will be sold.

The combined "Frannie" will administer a nationwide conforming balance that will apply to non-urban areas. There will be a separate conforming balance for congested MSA's, as well as the non-contiguous states.

The deductibility of mortgage interest will be limited to conforming loans with geographically varying maximums, and will also be subject to income-based means-testing.

When home prices decline, the conforming limit will be reduced - it will not be held at the prior years' level. Existing mortgage holders’ interest deduction will be grandfathered and honored.

No interest will be deductible by borrowers who did not demonstrate and document their ability to pay - based on either assets or income.

Frannie's $1.6 trillion retained portfolio [pdfs: Fannie: $770B; Freddie: $830B] will be offered to Eastern (either Mid or Far) sovereign wealth funds. The Treasury will provide these most-favored aggregations with a guarantee backed by the full faith and credit of the US government. State pension and nationalized automaker retirement funds will have the opportunity to receive equivalent terms.

In appreciation for the Eastern investors’ acquisition of the Frannie assets, their subsequent investments in US Treasuries will be enhanced:

  • Eastern investors will be able to put back, at par at any time, a portion of their holdings of US Treasuries.
  • The notional amount of their put option will depend upon their Frannie holdings.

Frannie will operate simply as a government-backed insurance company – guaranteeing timely payments of mortgages in exchange for a recurring guarantee fee that reflects the risks of the guaranteed loans.

2. Structured CMO's will be securitizations of agency securities (Ginnie or Frannie), rather than whole loans.

While senior/sub or over-collateralized securitizations will not be disallowed, issuers will be required to retain the subordinated classes, and treat the entire transaction as a borrowing, rather than an untrue sale. Credit manipulation will be, as Al Gore once described his recreational drug use - "rare and infrequent."

Financial engineering of residential mortgage assets will be limited to allocating the receipt – over time - of government guaranteed payments from mortgage obligations that conform to a mandated standard, with respect to underwriting and payment features.

Depositories will issue all securities. Regulators will raise "deposit" insurance premiums - based on assets, rather than deposits - of any insured institution that creates securities that do NOT conform to government standards.

3. Rating agencies (e.g., Fitch, Moody's, and S&P) will have virtually no role in the private credit structuring of residential mortgage securities. But they will still serve a key function, as described below.

Due to the virtual elimination of private residential mortgage credit enhancement, rating agencies’ "credit rating" role (such as it was) will not be missed.

Regulation of bankers' salaries will continue, even after the repayment of all TARP funding and the retirement of all FDIC-guaranteed bank debt.

Bankers' salaries will be subject to limits reflecting the salaries received by similar rating agency employees, with regional cost-of-living adjustments.

Equalization of compensation, between the rating agencies, as gatekeepers, and bankers, as gatekeepers, will ensure that rating agencies no longer find themselves as out-classed as the thug who brings a knife to a gunfight.

Finally, the credit rating agencies will be absorbed into the US government and become part of the US Treasury. This transaction will NOT be pre-announced by the US Treasury, and will be a surprise to all.

The salaries of the unexpectedly federalized rating agency employees will be administered by the Civil Service system.