Transparency through Financial Claims with "Fingerprints": A Mechanism for Preventing Financial Crises

H. Gründl, T. Post

Research output: Contribution to journalArticleAcademicpeer-review

Abstract

Lack of transparency in securitization transactions contributed significantly to the current global financial crisis. This article proposes an incentive-compatible mechanism for future securitization transactions that would increase transparency: financial claims with “fingerprints.” this mechanism would allow market participants at each stage of the securitization process to easily obtain full information about the underlying original risks and the superior claims that need to be satisfied before receiving their own payoffs. The mechanism would considerably enhance transparency in securitization transactions at the expense of some transaction costs.in 2007, the u.s. Housing market bubble burst, triggering a financial crisis that resulted in a worldwide recession. Often mentioned as contributors to the crisis are the securitization of mortgages and the repackaging, or tranching, of mortgage-backed securities (mbss) into collateralized debt obligations (cdos). Mbss and especially cdos exhibit a large degree of opaqueness (i.e., market participants often have limited information about the true nature of the risks of the underlying mortgages). Every additional repackaging has the potential for even more information loss. In the run-up to the crisis, this situation caused the market for these securities to dry up. Furthermore, banks that held these opaque securities faced major refinancing problems.the apparent collapse of the market for mbss has led many policymakers and commentators to demand stricter regulation of transactions and compulsory trading of asset-backed securities at stock exchanges. Some have even called for a complete ban on mbss.we propose an incentive-compatible mechanism that takes “fingerprints” of the original mortgages and of mbs and cdo transactions. By fingerprints, we mean a complete record of information concerning the original mortgage transactions and all subsequent securitizations of those mortgages. This mechanism would solve many of the markets’ problems without stricter regulation and without impeding the potential for innovation in the securitization markets. We believe that our proposed mechanism would offer advantages at all stages of the securitization process, albeit with some possibly minor transaction costs.our mechanism is related to recent proposals by several researchers, including suggestions to create a global risk map and a global credit register, to increase and standardize information on mortgages, and to set up a clearinghouse to support the regulatory authorities. Some proposals address systemic risks stemming from interbank relationships, counterparty risk, and the opaqueness of financial institutions. Our proposal, however, is targeted at the specific, but important, market segment of mortgage-backed securities that has experienced market failure. Our proposal is extensive, covering transparency for mbs and cdo payment structures. Moreover, our proposal does not entail stricter regulation of mbss and cdos; instead, it creates incentives for market participants to enhance transparency and thus keep alive the free market and its innovative forces. Despite our nonregulatory approach, our mechanism could be an integral part of a global risk map.our proposal is based on an idea put forward by harry markowitz, who suggested setting up, as part of efforts to address the immediate problems of the financial crisis, a regulatory body that would conduct an in-depth census of institutions that own securitized assets. The information collected would encompass detailed data on security claim structures and underlying mortgage risks. Markowitz also suggested that the information be used to solve some of the more severe problems of the current crisis—no confidence in financial institutions that hold securitized assets and no trade in “toxic assets.” under our proposal, a systematic collection of securitization transaction data could become the cornerstone of an incentive-compatible mechanism in securitization transactions and thus foster a revival of securitization markets without new regulations.
Original languageEnglish
Pages (from-to)17-23
Number of pages7
JournalFinancial Analysts Journal
Volume65
Issue number5
DOIs
Publication statusPublished - 1 Jan 2009

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