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Posts Tagged ‘repricing of risk’

The Wall Street Model is Officially Dead

Posted by Larry Doyle on June 16th, 2009 11:49 AM |

Dear friends, family, countrymen,

We are gathered here today to lay to rest a business model which revolutionized our financial industry. I have fond memories and knew the legendary “originate to distribute” well. In fact, I welcomed the opportunity to share the background and development of this model last November 12th, in writing “The Wall Street Model Is Broken….and Won’t Soon be Fixed.”

Regrettably, those charged with nurturing and protecting this model, in turn, cannibalized it. As such, today we officially gather to bury it. Tomorrow, President Obama will announce new guidelines and oversight for a new securitization model on Wall Street. The Financial Times provides a uniquely balanced perspective on this new model, Treasury Plans Strict Rules for Securitization:

The US Treasury is planning a sweeping overhaul of securitisation markets with tough new rules designed to restore confidence by reducing the incentive for lenders to originate bad loans and flip them on to investors.

The authorities plan to force lenders to retain part of the credit risk of the loans that are bundled into securities and to end the gain-on-sale accounting rules that helped spur the boom of the markets at the heart of the financial crisis.

Sounds like a very good idea. Clearly the model needed to be ‘reborn’ given the massive abuses and fraud which were promulgated under the prior model. Recall that the prior model, also designated as the “shadow banking system,” embodied 40-45% of the total credit injected into our economy. Can we raise a strong, disciplined, and well behaved “model” to replace that void? I have serious questions.

As we assess the potential for the “new securitization model,” we need to understand how the “prior model” grew so large. Well, not unlike the abusive practices employed by professional athletes with steroids, our “old model” also cut a number of corners. In so doing, the “old model” mispriced the true risks of a wide array of loans originated over a period of years.

The “new model” will look to address the proper pricing of risks in loans. How will it accomplish this proper pricing? (more…)

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