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Owning up

June 22nd, 2010 No comments

Now that the heat of the mortgage crisis has passed, Kyle Mrotek and Kenneth Bjurstrom of Milliman’s Milwaukee office think it’s time to confront the question of who ends up with the bad assets, and how much of them.

That’s the issue at the center of their article “Anybody know who owns the loans?”

Sorting through the debris of the recent financial crisis is going to take some time, especially given the complexity of the underlying financial instruments that were invented to spread the risk. Calling it a “veritable game of hot potato,” Mrotek and Bjurstrom point out that different participants face different risks, and different needs:

“Lenders are facing repurchase requests on mortgages underlying securities sold to investors. Mortgage guaranty insurers are going back over the loans they insured and rescinding coverage due to alleged fraud and misrepresentations. Financial guaranty insurers are trying to identify loans underlying wrapped securities with breaches or misrepresentations and requesting the mortgage-backed security transaction sponsor to repurchase, cure, or substitute the underlying suspect mortgages.”

At heart, the situation raises issues of counterparty risk and complicates how all the players can resolve their particular problems in the context of an interconnected financial system.

The solution according to Mrotek and Bjurstrom, which their article goes on to detail?

“Those who use the best methods to optimally navigate decision making will be better off than those who resort to guesswork.”