There was a very thoughtful op-ed written by Ethan Penner in Tuesday’s (25 Mar) WSJ – titled “Of Markets and Mortgages”.  Fair disclosure right off the bat requires noting that Penner helped pioneer the application of securitization technology to real estate finance during his earlier days. 

Penner makes several compelling points in his discussion – the first being that we need to have a cool headed, analytical approach to the current problems afflicting the credit markets.  He rises quickly to the defense of securitization, which has been blamed for much of the credit market’s malaise thus far.  He proffers an explanation which is one of the best we’ve seen written thus far –

“The problems are due to basic mistakes that even the most unsophisticated among us can grasp.  Lenders loaned too much money on too easy terms to borrowers who did not have the capacity to make their payments.  No alchemy by even the brightest minds on Wall Street could turn bad loans into good assets.  Sounds simple?  It really is.”

Penner goes on to note that securitization has become the dominant vehicle for raising debt capital to finance assets – it efficiently matches borrowers with lenders, and gives borrowers access to the largest pool of investment capital in the world – AAA bond buyers. 

He readily notes that underwriting of risk in recent years was lousy, and agrees that securities backed by poorly underwritten loans are in trouble.  Penner further outlines a couple of the proposals that have been floated to deal with the issues – move from mark-to-market accounting to some estimate of long term value and a return to portfolio lending.  His commentary on both is enlightening – neither truly would have prevented the bubble that has recently burst (and he reminds us that the last big credit induced bear market interval was induced by portfolio lenders violating prudent standards). 

Penner closes his piece by recounting an experience he just had at the convention center in downtown LA as he joined 2000 others bidding on 120 foreclosed homes.  He suggests the larger market function as the LA foreclosure auction did – allow buyers with sufficient cash access to assets, and the market will determine reasonable / rational prices for assets.  He offers a comment all perhaps should reflect on – “Let us not forget that the only value of an asset is what someone will pay for it, not some theoretical value derived from a complex computer model”.   He went on to describe how buyers were screened carefully and prudent financing arranged almost immediately. 

No doubt there will / would be some pain from allowing the market to right itself – lenders who survive will pay the price for bad decision making.  Borrowers will own assets they can afford – whether that be a multifamily property, an office building, or a home – and there will be price / value corrections, perhaps even very large ones. 

He opines that securitization will continue to play a major role in the credit markets, and warns against demonizing the system.  His argument that the securitization market will discipline and repair itself is a reasonable one with historical precedent, and he notes that bond buyers will no doubt require a larger premium.  We for the most part agree.  

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