The New York Times recently ran an article called “Seeking a Safer Way to Securitization” (Floyd Norris, Feb 6, 2010) that asked the fundamental question: can the world be made safe for the return of the secondary market, and, if so, is that a good thing?

The article noted that securitization grew as a way for banks to get around capital rules, as it was more expensive for banks to hold capital against the risk of the loans than to securitize them and sell them into the market. For no other reason than that, the loans were securitized. This also had the affect of opening the market to new entrants who wanted to originate loans but had no intention of holding the paper. This ability to quickly move the risk of a loan onto someone else’s shoulders helped to nearly bring down the entire global financial system and bankrupted entire countries like Iceland.

So does the U.S. need a securitizations market? Canada doesn’t. (I got in an argument once with a Canadian banker over dinner about this). The answer, according to the Times article, is probably yes.

Norris quotes U.S. Comptroller of the Currency John C. Dugan as telling the American Securitization Forum, We need a vibrant, credible securitization market to help fund the real economy going forward.” Ninety-five percent of the U.S. mortgage market currently depends on government guarantees (through Freddie, Fannie, or FHA.) When that dries up, the market will surely suffer without a healthy alternative.

Again according to the Times’ Norris, two fundamentals changes are needed to fix the securitization market: 1) The underlying loans have to be better quality; and 2) Investors have to believe in that quality and be rewarded for their risk.

“We must have better loans,” Michael H. Krimminger, the deputy for policy to the FDIC’s chairman, said in an interview with Norris, “One way is to have regulatory fiat. That is important, but it is not sufficient.”
Let’s let Norris take it from here for a moment. He writes, “If the private securitization market is to be revived, would-be investors will have to be persuaded there are better safeguards. Such persuasion seems likely to include more disclosures, more time for investors to review loans before securitizations are completed and perhaps [more] rules. […] [but] mortgages are highly dependent on individual facts that are not easy for an investor to review. Is the borrower really responsible? Is the house really worth this much?”

I have been saying the same thing for years now. Maybe that’s why I think Norris is a genius.

I use the word “transparency.”

The Government can impose new regulations and investors can demand higher hurdles to secure their investment, but both require the appropriate technology to be in place in order to be effective. The appropriate use of technology can empower financial institutions to deliver the necessary levels of efficient transparency to make the securitization market work.

A lot of technology investment since the crash has been on the side of servicing and default management — for good reason since that where the money is. The government is spending billions of dollars on stabilizing the market by trying to keep people in their homes. Personally I think that is the right thing to do. But that investment does nothing to establish the transparency that will enable the securitization market to come back. Short-term stabilization and “band-aid” measures were necessary in the short term, but long-term cures require continued investment in the right solutions – those that bring permanent change in the way of increased efficiency, with accountability and compliance built into the system.

I get excited about that idea, to be part of the rebuilding the world’s number one economy. To me that’s better than working on global warming, electronic cars, or an iPhone App. In fact, I think this is the sexiest place to be in Silicon Valley. While Facebook can connect me with my old high school friends, and OpenTable can help me get a great restaurant reservation in the city, neither can bring the global stability that comes from a healthy world economy. While it may seem a stretch to suggest that origination technology holds the key to worldwide prosperity, it has a not insignificant role to play.

I think that a shift must be made from lender-centric process tracking confined to the four walls of the enterprise, to an open market-centric approach of information management and data orchestration.

Simply put, today’s processing systems do no more than manage tasks in processor’s queues, check off underwriting conditions, order documents, trigger funding, then send a small bit of information to a back office system for accounting and servicing the loan.  Investment and expected ROI is made on processor efficiency – making more profit in origination.

The new model, I believe, is a system that takes its place in the value chain itself – from application past funding to securitization.  Systems need to collect information over the Web, verify and analyze that information, enable processing of that information, and then orchestrate the dissemination of that information.  Investment is made on quality, ROI is measured based on the value of the asset AND on productivity – making more profit not just by doing more operationally with less, but also on the value of the originated loan itself.

That comes from transparency.

The Internet is made for transparency. That’s why I believe any technology solution must reside on the Web.  It can be a lender specific technology platform or one that many lenders use at the same time but I believe that the key technology beyond workflow approaches, collaboration techniques, integration hubs, data warehouses, and decision engines, is “the cloud”.  And that is because only in the cloud can any solution be part of the value chain; integrated with other companies that bring value to the borrower, to government in its new relationship to the chain, and most notably, to the investor.

In the cloud, a promising new technology is XRBL.  Dorado is exploring this new idea.  XBRL is an open markup language from the roots of XML that can make financial reporting elegant and simple.  Wired magazine wrote an article on this technology and its potential impact on the securitization market (“Road Map for Financial Recovery” – 2.23.09).

XBRL is currently focused on SEC accounting.  Last December the SEC mandated that every company with a market capitalization over $5 billion will be required to submit filings using the format.   This allows investors to be able to run their own reports against reported information.

The same technology can be used for marking loan information – providing volumes more information beyond addresses and  credit scores. Information including why the bank made the decision, what processing workflow was used to originate the loan, what fraud analysis was done on a loan and the stakeholders associated with the loan, and especially what compliance and regulatory standards were adhered to in providing the loan.  This, in turn, will make an investment made up of securitized loans more attractive to investors.

Unlike my Canadian friend, I believe that a healthy securitization market is necessary for the overall health of available credit and the economy.  I agree with Norris’ assertion on the need for quality that comes from transparency.  And I get excited about the role technology and the cloud can play in that.