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Lesser Financial Reform Without A Technology Vision
So, What about Financial Reform?
Every academic, bank CEO, and politician has their own idea about reforming the financial and mortgage systems in America. The Dodd Frank Act is the objective and catalyst for the debate on reform.
Like Dodd Frank, opinion leaders offer structure without vision. Their intellectual concepts do not consider the capabilities of lenders to survive, nevertheless prosper after reform. The most far reaching financial services legislation in eighty years has been passed without benefit of an impact.
My main issue with the legislation is that financial reform does not consider the technology available to lenders. Here, I refer to technology in the larger sense. Technology in my thesis means the combination of knowhow and the application of machines, software and people to manage under new rules.
Our MORTECH data has shown over many years that most lenders do not have the risk and business intelligence systems to run their business effectively. Lenders are underinvested in business intelligence and risk management systems. The effect of financial reform undoubtedly will be diluted unless and until lenders conform to professional management standards enabled by (decision) technology.
Solutions Offered by the Experts
The Mortgage Bankers Association of America (MBA) has jumped into the melee with both feet. MBA says that they have assigned an inordinate, but appropriate set of resources analyzing and influencing rule-maker response to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (The Dodd-Frank Act).
The MBA recommends that the centerpiece of federal support for the secondary mortgage market would be a new form of mortgage-backed security issuer – the mortgage credit guarantor entity (MCGE). The MBA sees that a mortgage backed security (MBS) would have two components:
a) A security-level, federal government guaranteed “wrap” and
b) A private, loan-level guarantee from a MCGE, something that functions similarly to Ginnie Mae.
The mortgage credit-guarantor entities (MCGEs) would be privately owned, but government-chartered and regulated. The guarantees of on-time time payment of principal and interest would be secured by a federal insurance fund, fueled by risk-based fees charged for the securities at issuance and on an ongoing basis.
Underlying the MBA concepts is a minimally encumbered flow of credit to qualified borrowers. The MBA also would preserve “reasonable levels” of lender discretion when originating low-risk loans.
The Private Market Alternative
Stumping from their rostrum at the American Enterprise Institute, Peter Wallison, Alex Pollock and Edward Pinto think they have a solution to reform – removing government almost entirely. In their new paper “Taking Government Out of Housing Finance . . . .” the three intellectual powerhouses show how they would push mortgage finance away from government involvement. The most salient point in their thesis for a new secondary mortgage is: “To the extent that regulation is necessary, it should be focused on ensuring mortgage credit quality.” The government’s stake in the business would be focused on a higher standard of lender identification and management of risk.
The MBA and Mssrs. Wallison, Pollock and Pinto differ markedly about the government involvement in its liability for carrying and managing credit risk. The AEI team holds that investors will buy mortgage paper not guaranteed by the US government. Liquidity in the market would occur organically. MBA thinks a government pool to guarantee mortgages is a more workable alternative to private or public-only guarantees.
The Middle of the Road Alternative
Dr. Mark Zandi of Moody’s Analytics has considered a range of reform models – nationalization, privatization, and, well, a “hybrid” solution.
The hybrid mortgage finance system features risk sharing. Initially, Zandi would allow private operators to bid for basic GSE transaction and processing systems needed to replicate secondary market operations. Administrative, oversight and review functions would be ceded to the federal government.
The private operators would invest their own capital in the credit enhancement and portfolio businesses. They would originate, own, and manage the mortgage assets and the insurance portfolios.
Such a system holds the most promise for delivering consistent, affordable mortgage loans on prudent terms to borrowers, with minimal costs to taxpayers.
According to Zandi, the private operators would absorb first losses and operating cost. The federal government would backstop in case of catastrophic losses. Zandi believes that this system retains the incentives for the operators to run a prudent book of business with loans priced appropriately for cost and risk. And, what of the government’s role? The government backstop would lower asset risk premia, lower borrower costs and keep mortgage credit flow freely.
The Role of Technology
It never fails! No one offers the complete solution to reform or for any other matter of magnitude.
We at MORTECH, LLC have long held that underinvestment in data and knowledge technologies chronically contributes to financial crises. The most telling is lenders’ lack of understanding of the risk they create when originating a loan or when investing in mortgage servicing rights.
For example, at the height of the credit crisis, only one-third of lenders had the ability to manage interest rate risk in their pipelines.
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Dodd-Frank, the MBA, and the American Enterprise Institute notwithstanding, financial reformers will have a rough go unless lenders have the tools and the knowhow to manage their businesses better.
The Dodd Frank Act is 848 pages long. In all of that, technology gets only 9 mentions throughout the whole Act. Essentially all of these refer to technology that might be used by regulators themselves.
Financial reform will be more successful if the Act had a complete vision supporting it. Then too, the interpreters and influencers for rule-making would be more persuasive armed with a model of business and with operational standards.
The industry certainly would be the better for it.
Jeff Lebowitz
January 26, 2011