We are now near the end of the third year of the financial crisis and still nothing has been done to reach deep into the supply chain and correct the core problem: wealth and credit are still not being distributed where they are needed most.

Yes there has been strong legislation passed to re-regulate the financial sector and provide the central government regulators extraordinary powers of supervision.  There have been incentives offered to spur the housing sector.  The FED is managing the money supply to insure low rates are available (hopefully to allow for lending to expand employment opportunities too); all admirable and necessary. 

Yet there are two areas woefully overlooked; basic credit underwriting and providing a clear view to investors of the loan level data allowing them to use their own tools to properly assess risk.

Time and time again we've heard lenders say their hands are tied when trying to extend credit to worthy borrowers because they do not meet underwriting guidelines tied to “artificial intelligence” systems and coded credit rating models. Sound credit underwriting is not collecting data from a borrower and uploading it to an automated risk model. These complicated mathematical formulas are performed in the abstract while abandoning the application of subjective factors that every good lender once used to assess the reliability/capability of the borrower to repay the credit line requested. 

While it is true that you can mathematically predict many things, the one thing you cannot predict is an individuals will to persevere and make payments in the face of economic turmoil. Perhaps one of the keys to avoiding future credit failure is to place less reliance on “artificial intelligence” and more on human judgment based on sound lending principals.  

The same ability to judge credit worthiness must be placed in the hands of the securities buyers as well.  The securitization of mortgage loans is absolutely necessary if we are to continue to efficiently provide credit to the market.  Yet the investor confidence necessary to have a well balanced market will not return until they feel comfortable with the associated risk.  The much discussed and now almost cliché term “Transparency” really is what is required. 

To provide the investors with a sufficient level of transparency without violating privacy rules is not impossible.  In fact the tools are available right now and every originator, lender, aggregator and issuer of securities should implement the universal application of using those tools.  Assigning every loan closed a Mortgage Identification Number (MIN) is the first step, capturing the 1003 and 1004 data from the credit application and the appraisal is the most basic step and then supplementing that data with MLS and recent sales data will provide the securities market with the basic tools required for proper pricing, sizing, risk assessment and structure.  Once again there is nothing suggested here that is not already available and at various levels being implemented.

By returning to a common sense approach to underwriting, proper use of the collected data, implementing easy individual loan identification and discarding 100% reliance on purely objective underwriting tools we will be able to provide credit at every level of need properly priced.  The loans will then be securitized in an open and transparent environment, permitting proper risk assessment, security structure, and pricing for each level of risk.

The question: Do these simplistic yet effective changes require legislation to force their implementation or is the market capable of making a common sense course correction on its own?