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Recovery in the mortgage market will take time and will require more market and regulatory discipline, Governor Randall Kroszner said, underlining that clarity and simplicity will be key issues.
Krozner expects that the originate-to-distribute model will continue to be an important part of the modern financial market landscape but ‘in a much stronger form’. “The model works best when the resulting credit instruments are less complex and opaque”, he said and called for credit instruments that are less complex and opaque.
"The process of recovery and repair in non-agency mortgage securitization markets would also be aided by more clarity and consistency in underwriting standards”, he said. The Federal Reserve will issue its final regulations on mortgage lending and advertising practices in July, he announced.
Credit ratings agencies failed to understand, or at least to make clear, that investment-grade ratings on some mortgage-backed securities, particularly collateralized debt obligations (CDOs) backed by sub-prime or alt-A mortgage securities, carried greater risk than traditional investments with the same ratings.
Many large, complex institutions had exposures to sub-prime mortgages that ran across independent business lines, through off-balance-sheet conduits such as structured investment vehicles and with respect to numerous counterparties such as monoline financial guarantors, Krozner outlined. But too few institutions fully recognized their aggregate exposure to risks that turned out to be highly correlated.