LAX UNDERWRITING STANDARDS AND POORLY DESIGNED SECURITIES
With lenders able to remove assets that they originate from their balance sheet and therefore transfer credit risk via securitization, a major concern is that this process has motivated lenders to originate loans with bad credits. Given the ability of lenders to pass along loans into the capital market via credit enhancement (a large part of which is just the excess spread), lenders have been viewed by critics of securitization as abandoning their responsibility of evaluating the creditworthiness of potential borrowers.
This practice has been followed by banks who have securitized their subprime lending portfolios. For example, in an article in the online edition of the October 7, 2002 issue of Business Week (“The Breakdown in Banking”) the following appeared:
By selling off their loans, banks were able to lend to yet more borrowers because they could reuse their capital over and over. But it also meant that they made lending decisions based on what the market wanted rather than on their own credit judgments. The wholesale offloading of risk made the banking system less of a buffer and more of a highly streamlined transmitter of the whims of the market.
Banking regulators are well aware of this issue. On July 11, 1997, the U.S. Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System sent a letter to the officer in charge of supervision at each Federal Reserve Bank ...