Comments on: Fixing Securitization

By: David Merkel

David Merkel — Wed, 22 Oct 2008 17:21:07 +0000

Marketability is limited by heterogeneity of credit instruments underlying the deals, lack of transparency (sometimes hard to get deal data if you don’t already own the deal), and thin tranche sizes, aside from the most senior tranches. But if you have the data on the corporate credits, they are simple to model.

By: DaveinHackensack

DaveinHackensack — Wed, 15 Oct 2008 18:20:21 +0000

David,

Your proposal makes sense. Regarding this,

“In my opinion, CDOs aren’t complex, unless they include other structured finance products inside them.”

What then explains the lack of a market for CDOs (the ones that aren’t comprised of other structured finance products)? Is it the heterogeneous credit quality of the underlying mortgages?

By: David Merkel

David Merkel — Wed, 15 Oct 2008 16:17:36 +0000

J Lo, If the amount of equity in the deals is sized properly, then the risk to the more senior tranches becomes minor. My proposal implicitly wipes out the tranches that are less than single-A in terms of risk. It also would force originators to focus on quality lending, or else, they would lose money on every deal.

If lending quality is high and leverage is low, there’s no problem. It would be akin to a well managed bank making corporate loans. That said, my proposal reduces the profitability of securitization… many originators did not put up much if any money, so any payments from the equity tranche were gravy.

In my opinion, CDOs aren’t complex, unless they include other structured finance products inside them. Will this totally solve the illiquidity problems? No, but the new CDOs will be higher quality, and their debts more liquid.

By: J Lo

J Lo — Wed, 15 Oct 2008 13:01:34 +0000

While the general quality of the CDOs is imperiled by perverse incentives, isn’t the current state of affairs (IE no one being able to value the CDO, thus the formation of TARP) a direct result of the way these securitizations are structured?

That is, aren’t these so complicated that no one can easily examine the actual quality after the SHTF to accurately determine their worth? Is the housing bubble made worse by securitization as it is currently constructed?

By: David Merkel

David Merkel — Wed, 15 Oct 2008 11:16:55 +0000

No, Frank, you are largely right, though few equity pieces accept zero coupons. The idea is that the equity gets paid last — no interest, no principal, until everyone else gets paid off.

By: frank

frank — Wed, 15 Oct 2008 11:05:16 +0000

Correct me if I’m wrong, but aren’t most auto loan ABS deals already structured in a very similar way to your suggestion? I thought the main culprit of this was actually the RMBS deals with step-down mechanisms?

By: David Merkel

David Merkel — Wed, 15 Oct 2008 10:14:16 +0000

Chris, thanks. I know Equity Private writes over at DealBreaker, but I don’t read DealBreaker because of the tone there, and the low signal/noise ratio. Maybe that has changed with Carney leaving and EP contributing, but sites that make it their permanent goal to rake muck get an attitude that makes them less reliable.

By: Chris

Chris — Wed, 15 Oct 2008 07:15:14 +0000

David,

FYI, while Going Private is mostly inactive, Equity Private is posting all the time at dealbreaker.com if you’re interested.