Earlier this month, the Wharton School’s online newsletter – Knowledge@Wharton ran an interesting piece entitled Coming Soon … Securitization with a New, Improved (and Perhaps Safer) Face. The article quotes a number of Wharton’s finance and real estate professors on what the reforms are needed in the real estate and securities market. I was specifically interesting in there comments on the securitization process (as opposed to the underlying real estate market). They make the point that the securities market became too complex and complicated which resulted in overly risky investments and a crisis of confidence as those investments collapsed. The article quotes Professor Richard Herring as saying, “there has been a highly rational flight to simplicity.”
Interestingly, Peter Morici at the University of Maryland School of Business made a similar point in a recent piece one overall economic and trade policy — Rethinking Fed Policy – Forbes.com:
In addition to adjusting interest rates and bank reserves, Bernanke needs to sit down with the largest banks and fixed-income investors to define simpler, more transparent loan-backed securities that bond-rating agencies can more reasonably evaluate and that fixed-income investors can purchase with confidence.
These are the same points I have made before as well — and the reason why I believe there may be an opportunity here for intangible asset securitization, as I note in our new Athena Alliance working paper (Intangible Asset Monetization: The Promise and the Reality). Investors need a clear understanding of the asset underlying the security, the risk associated with that asset and the revenue stream generated by that asset. Intangible asset back securities can be crafted with that transparency. And if the nature of the risks involved is acknowledge upfront, specific measures can be taken (and clearly explained) to mitigate that risk. That may be of more comfort to investors than the previous practice of assuming an AAA rated security was risk-less.
Ultimately, the future of an intangible asset backed securities market will depend on the creation of a primary market in intangibles. Certain intangibles — book and music rights — are routinely bought and sold. It is no surprise, therefore, that music rights were among the first to be securitized (the Bowie Bonds). In other areas, such as patent, rights have long been traded but organized markets are just beginning to emerge.
Helping these primary and secondary markets will require a number of actions, including patent reform (to ensure that the patent is really worth something) and maybe the creation of an institution akin to Fannie Mae/Freddie Mac (an Ida Mae). (See earlier posting for a list of the most important policy recommendations).
In any event, securitization is here to stay. As we fix the problems from the previous abuses, let us not only prevent future bad things from happening. Let us also explore ways to make good things happen in the future. Promoting responsible securitization of intangible assets would be one of those good things.
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UPDATE: Another opinion on securitization, from Bob Pozen (How to Revive Securitization Markets – WSJ.com):
Most markets for securitized debt have dried up. The cause is uncertainty: Since no one knows exactly who owns the potential losses from securitized mortgages, many investors stay away. When the Securities and Exchange Commission Advisory Committee on Improving Financial Reporting meets on Friday, it can take a big step toward reviving this critical part of our financial market. It should recommend that the regulators require someone to “own” the securitization process as well as require more disclosures about who will bear the losses from the assets underlying these securities
. . .
The market for securitized assets can revive if trust sponsors make these disclosures and an independent holder of substantial trust equity is given some governance powers. Under these conditions, FASB can safely continue to allow bank sponsors to keep the trusts off their balance sheets – a necessary step lest we go back entirely to banks holding mortgages to maturity and lose the increased funding available for home purchases generated by the securitization process.
I don’t know about the specifics of this proposal, but I wholeheartedly agree that someone has to “own” the securitization process — not just own the financial paper. As I understand most current intangible-asset backed securitizations, there needs to be an active manager of the trust to ensure (and maximize) the revenue stream. Such deals often also come with strict performance measures and backup arrangements. That is another reason why clear rules and a model for intangible asset backed securitization are needed.