You say distillation, I say desecuritization

In the comments here and in his own blog, Sean DeCoursey has been pushing what he calls “distillation” as the solution to the near-total freeze-up of securitized lending:

Distillation is the opposite of securitization. All the various components of the securitized debt are pieced back together into one single coherent original whole. That means instead of an MBS made up of 9000 loans, you slice up and sew together 9000 MBS’ to get 9000 original loans. By distilling the original loans out of the mess of loan securities, you create an object that can be easily and quickly valued and traded. Individual debt obligations like a single mortgage are possible to value. They could be traded. People and institutions would know how much they had lost, and how much they still had. The uncertainty that continues to confound the financial sector, and markets in general, would subside. Without the continual threat of collapse and new reports of staggering losses, businesses could begin to recover.

Well now Jack Guttentag, “The Mortgage Professor,” seems to be pushing the same idea. Only he calls it “desecuritization”:

Desecuritization means reversing the securitization process. Securitization converts large numbers of individual loans into security issues. Descuritization converts the securities back into individual loans. The objective of both is the same: to enhance value. The first works during normal periods, the second can work during a crisis period such as the one we are in now. …

All that is needed to make desecuritization work is a way for investors to acquire control of 100 percent of a security issue. The investor who owns it all can dispose of the security and own the individual loans. To make this possible, we need a law that grants any investor who owns X percent of a security issue the right to buy the remaining 1 minus X at a price equal to Y percent of the average price the investor paid for the X percent already owned.

In theory this sounds really compelling. I’d be interested to hear if anybody out there thinks it’s at all practical.

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strawmn

Interesting idea. The largest barrier will likely be the size of the MBS market – is there an orderly way to identify majority investors for individual loans, price, and move them in efficiently?

There’s also going to be a functional problem that there is real toxicity in these securities. Right now we’re unsure of how much, and this process can seperate the wheat from the chaff. But as you move the performing and relatively safe loans from the security, eventually you’re going to be left with some very toxic, very non-performing loans. You’d have to assume that the “Y” price is going to be heavily elevated – what happens to these mortgages? Do they remain in group owned, non-liquid securities?

There’s still a bit of a benefit from this (they’ll be isolated and can be more effectively priced) but it is going to leave a bit of a mess around the system.
qqi239

Let us not allow another professor to set a price of security – we collectively stepped on these rakes way too many times in recent years.

It is not that complicated: all we have is to get information from all holders of particular issue, the price its parts through the distillation process sell it off at auction.

If the self-interest would not be a sufficient force to bring holders together it could be backed by making non-participant’s holdings to expire after say 1 year.
funkyfred1933

I would love for this to happen. I’d stop paying my mortgage and, when the price was low enough, I’d buy it.
dotybj

The purpose of securitization is not to “enhance value,” it is to provide liquidity and match those who wish to lend capital with those who wish to borrow capital. In the case of MBS, it matches institutional investors with homeowners. The problem is the lack of transparency. The reason it is difficult to value an MBS is not because there are a lot of loans in it, it is because you don’t know what the loans are.
http://www.124monkeys.com Sean DeCoursey forgot his password

Bah. I had a big huge long comment, but it got eaten by the internet. Short version: Individual desecuritization won’t work because there are too many owners and it leaves lots and lots of “partial” MBS’s behind in its wake. The only way to accomplish this successfully is to have a large government buy up of everything all at once, unspool all of it, then sell it back off right away.
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The point here isn’t to create value or make anyone money, they point is to create reliable values for these things and get everything ungunked. My personal pick for the government to do this is China. China has the money in dollar reserves to pull this off, and desperately needs the world economy to not sit in a prolonged recovery in order to continue fueling exports.
plukasiak

the real problem isn’t the MBS’s, but the CDS’s based on those MBS’s. the minute you start setting prices for a security, the credit default swaps associated with that security come into play. Indeed, the real problem may not be the securities, but the “insurance” (the CDSs) on those securities that turned bad mortgages into “solid” investments.
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IMHO, a far better solution is a change in the laws that allows the refinancing the mortgages that are the basis of those securities at a loss to the holder of the securities without penalty to the mortgagee based on current real estate values. In this way, the securities themselves are paid off based on the current underlying asset value, and new (and more stable) securities can be issued.
Justin Fox

@Sean DeCoursey forgot his password: My personal pick for the government to do this is China. China has the money in dollar reserves to pull this off, and desperately needs the world economy to not sit in a prolonged recovery in order to continue fueling exports.
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Yeah, and I bet already-marked-down mortgage securities would turn out to be a much better investment for them than Treasuries.
qqi239

“I bet already-marked-down mortgage securities would turn out to be a much better investment for them than Treasuries.”
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Huh? Are you serious that China (and others) were and are buying Treasuries because they have some investment value???????
atworkforu

It could be a good idea if it is possible to piece the mortgages back together like the T2000. As I understand it, a really big problem with getting mortgage modifications through is that the least senior tranche of a MBS would be wiped out if they agreed to the mod – why not hold out and see if your slice is worth something? If the mortgage could be reassembled it may be worth more as a mod with a temporarily reduced rate or extended term then by going to foreclosure.