IN BRIEF
- The securitization of mortgages model could be helpful in helping small businesses through the COVID-19 pandemic.
- The model demonstrates how to securitize complex instruments such as mortgages, suggests that the holders of the notes should be the institutions that have the most experience in this function, and keeps politics out of it.
INTRODUCTION
Many small businesses, whether restaurants or small shops, are presently closed, and many of their employees are laid off. Currently, the government is lending money to small businesses and unemployed workers for their sustenance then collects the payments from some of the borrowers and the rest from taxes. Given that not all, or perhaps only a few, small businesses own real estate, they sign notes to repay the loans but can offer no asset backing. Presumably, then, the nation’s financial deficit is growing. The government adds the aggregate of the loans to the country’s costs and tax collection. However, even though support and politics might rub shoulders, they often harm each other.
1. Is there any other way in which some, if not all, of these loans could be financed by investors? An imperfect model that was tried and succeeded for some time to some extent was the securitization of mortgages. The good and bad experiences of mortgage securitization could help design a better securitization system for the notes of small businesses and employees. To be sure, mortgages are more solid backing than notes. In addition, although we have a long track record of recessions, and therefore a good sense of what recovery looks like in the current case, we do not and cannot know what the aftermath of the pandemic will be like. It might well cause a fundamental change to our economy and—just as importantly—changes in people’s habits.
2. The securitization of the notes is not similar to that of mortgages and to mutual funds holding notes. The comparison of securitization of the proposed notes to the securitization of mortgages or to pools (mutual funds) of corporations’ notes is not precise. In fact, the first step of securitization was the pooling of notes, but they were offered by very large corporations. In addition, there are currently mutual funds that hold relatively small notes issued by corporations. They are fairly safe and help both parties. In addition, small business investment companies make equity and debt investments in small businesses, and business development companies generally invest in the debt of middle-market companies.
Small businesses during the pandemic era are different from mortgages during a market decline. Most small businesses do not own real estate, but rather rent their business space. The notes they issue are of relatively small amounts. They may already have outstanding loans. They may not reopen even after the virus is overcome. Supported employees might not return to work for health, age, or other reasons. In sum, the borrowers’ note obligations are fairly risky.
3. Would health recovery bring the same businesses to full life? Not necessarily. Restaurants, for example, may have to share their business with the rising food and cooking suppliers and services. Besides, unlike the quest for home rental or ownership, people may have changed their habits of meeting in restaurants. Habits take time to form, but once they do, they take time to change or revert to old or other habits. History demonstrates a similar result; for example, the “buggy whip” was necessary and highly used for transportation before cars took over.
4. In sum, the risks associated with loans to small businesses is different from the risks of loans in a traditional recession. To be sure, the government could substitute its direct lending by insuring some of the risk associated with the notes portfolio. That would give lending banks a measure of comfort in that should a wave of bankruptcies occur as a result of these general economic and habitual changes, they would not get caught holding all or most of the bad notes. Another possible support is the government’s guarantee of bank losses, although some of the notes will support not only the banks’ business, but also the small business.
5. What are the benefits in pooling such small notes and selling participations in the pool to investors? Why would investors buy such participations?
The Treasury may help. Let the Treasury give a discount from taxes to such investments. For some investors this might be sufficiently attractive to cover the risk of failures to pay the notes. The benefits of securitizing these notes are numerous not only for one participant, but also for many participants and the entire country.
The notes-issuers will not be worse off, except that they might be subject to bankruptcy rules rather than viewing their obligations as fully enforceable. There is some justification for this reaction, yet the law may offer the borrowers in this case some relaxation as relief, and if the issuers go through banks, the government may allow banks the type of relaxation that would help the borrowers. No law is necessary for these rules because the Treasury has the authority to offer it, provided it is offered to all banks in the same position. In fact, banks currently have some discretion to relax their requirements with respect to any borrower—that is, although banks ordinarily are reluctant to lend to borrowers that are close to bankruptcy, they may set different criteria for this type of borrower.
Investors may be somewhat worse off compared to lending to other businesses; however, (i) their investments are not a donation; (ii) the investment should be given the public recognition it deserves; (iii) the successful revival of any supported business should be publicized; and (iv) the recipients of the money should be given a platform to thank the anonymous buyers of the securitized notes. Pictures could show the opened restaurants and, if they so wish, their owners and workers. These are not and should not be financial rewards, yet they may be valued more than any money rewards. The satisfaction of helping while risking some of one’s money may balance the risk.
However, the donors’ names, whether personal or incorporated or in groups, should not be publicized. If pressure to publicize is great, then it would be allowed only if the donees’ group-members are joined. In sum, business and finance need not be drained of all humanity and the satisfaction of sharing.
In addition, banks should institute appropriate safeguards. The bank should be responsible for the quality of the manager of the pool. In addition, the cost of the pool should not be charged to any other mutual fund or pool.
The conclusion that applies to securitization generally seems to apply to the securitization of notes by workers who lost their jobs and small businesses that had to close down. “[S]ecuritization seems to be going in the right direction at this stage. It allows credit to more risky borrowers but reduces the risks from such borrowers. Securitization also contributes to increased debt by borrowers and intermediaries but reduces such risks to investors.”
6. What is the effect of securitization on monetary controls? When dealing with mortgages, the conclusion was the following:
Securitization renders the Fed’s control over the money supply more complex. However, monetary controls are an art rather than a science. The captain at the helm both guides and is guided by a faulty compass. Since the captain never had a scientific compass, it is doubtful whether the country is worse off today than before the emergence of securitization [of mortgages], technology, and competition.
CONCLUSION
The model of mortgage securitization is helpful in various ways.
First, it demonstrates how to securitize more complex instruments, such as mortgages. Pooling notes is simpler and has continued to be practiced, providing more experience.
Second, it suggests that the holders of the borrowers’ notes should be the institutions that have the most experience in this function, i.e., the banks, rather than the Treasury, which has some but not as much experience in this function and is charged with and focused on matters other than managing other people’s money and debts.
Third, it is important to manage securitized debts without political and other national pressures, such as the money supply. If we agree that those who need help should not be affected by the financial system’s politics, then let us focus on helping them without any political self-interested and conflicting national interests. We should help those who are suffering from this pandemic, respect them for avoiding a handout, and honor the borrowers who are expected to repay. Let those who are required to pay through taxes or give to charity give the needy ones in this case an equal status—they are parties in a financial deal.