FHA-MIP-to-Increase-in-April.jpg" title="FHA MIP to Increase in April" width="275" />(Bloomberg) -- As we should have learned from the 2008 financial crisis, the mass production of securitized credit enables reckless borrowing, shortchanges productive businesses and destabilizes banks. It has been nourished by regulation, not its inherent economic advantages. Yet officials in Washington continue to favor this top-down misdirection of credit.
To end this bias before it does any more damage, the federal government needs to get out of the securitization business altogether.
The infatuation with securitization goes back 25 years. In 1987, Lowell Bryan, a McKinsey & Co. director, argued that securitized credit would transform banking fundamentals that hadn’t changed since medieval times. Since then, many cheerleaders in academia and the financial industry have extolled the virtues of securitization, arguing that by combining advances in financial and computing know-how, it slashes the costs of lending, improves the evaluation and distribution of risks, makes credit decisions more transparent, increases liquidity, and so on.
Securitization has certainly transformed banking, as Bryan predicted, and fueled an explosive growth in private borrowing. Besides mortgages, securitized assets now include car loans, credit-card balances, computer leases, franchise loans, health- care receivables, intellectual-property cash flows, insurance receivables, motorcycle loans, mutual-fund receivables, student loans, time-share loans, tax liens, taxi-medallion loans and David Bowie’s music royalties. Securitized assets have also helped build a gigantic over-the-counter derivatives market that was practically nonexistent in 1980.
Yet this transformation has also had serious downsides. Yes, computer models reduced costs and increased volumes. But in lending, as opposed to selling widgets, more isn’t at all better. Bankers have to discriminate between borrowers who can repay and those who can’t. Securitization models devised by remote wizards fail for the same reason that Friedrich Hayek argued central planning doesn’t work: They rely on a few abstract variables, ignoring specifics of time and place. As with central planning, erroneous models can also lead to systemic failures.
Securitization discourages lending that can’t be easily mechanized: Banks lose interest in making loans to small businesses. Troubled loans end up in needlessly destructive foreclosures or lawsuits because a one-on-one negotiation between a lender and a borrower is impossible.
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