The banks aren't lending! So says Congress, anyway. But that's because the largest banks -- such as JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C), Wells Fargo (NYSE:WFC), and Bank of America (NYSE:BAC) -- are still the in the process of shoring up their balance sheets. Meanwhile, smaller banks such as Regions Financial (NYSE:RF) are dealing with commercial real estate problems. However, the lion's share of the difference between pre-crisis lending levels and the ones we're seeing now boils down to the securitization market.

According to Bob Pozen, chairman of MFS Investment Management and author of the book Too Big to Save? How to Fix the U.S. Financial System, in 2006, the total securitization of all loans was nearly $1.2 trillion. This year, the securitization market equates to roughly $40 billion or $50 billion.

"Lots of political leaders ask, 'Why aren't the banks lending more?' The banks aren't the key to loan volume. The banks only accounted for 25% of lending, and they don't account for loan volume," Pozen said in an interview during a recent visit to The Motley Fool's headquarters. "Securitization allows you to make a loan, sell it, and continue. ... There's a total loss of confidence in securitized loans at the moment, and we need to change that."

Reviving the securitization market
So how can we safely revive the securitization market? Pozen says we need to do three things:

1. Make sure everyone has skin in the game. Pozen says we should stop making no-down-payment loans and prohibit mortgage brokers from selling 100% of a loan without retaining a loss. "Congress has before it a provision that says if you sell a loan to the secondary market, you need to retain 5% of the loss," he said. "That would be an important step."

2. Continue using off-balance-sheet entities for the purpose of securitization, but instill safeguards and transparency. "A lot of securitization was done in off-balance-sheet entities that nobody knew very much about," Pozen said. "It was a shock to shareholders when Citigroup took $30 [billion] or $40 billion on its balance sheet from off-balance-sheet."

Pozen says he believes off-balance-sheet entities are necessary and that they should engage in securitization. But, he says, the sponsors need to specify their obligations going forward. Specifically, they should disclose whether they have credit supports or liquidity obligations. He says the sponsors need to backstop their securitized loans with capital and engage in continuous disclosure. Lastly, since some structures were so complex that no one could understand them, Pozen says structures need to be simplified.

3. Reform credit-rating agencies such as Standard & Poor's (a division ofMcGraw-Hill (NYSE:MHP)), Moody's (NYSE:MCO), and Fitch. Pozen says more disclosure is needed and conflicts of interest must be amended. Specifically, he says the basic problem with credit rating agencies is "forum shopping," which is when companies shop around different rating agencies for the highest rating on their debt. (They do this to ensure the lowest cost of financing.) In theory, Pozen says, you would want to have the investors hire the credit-rating agencies, not the issuers. However, he admits the problem is that the big investors believe their analysts are much better than the analysts at the credit rating agencies. "So they are not going to pay for credit ratings, [which makes it] hard," he says.

The situation brings this question from Pozen: "How could you have a system where companies like Fidelity and Prudential (NYSE:PRU) and firms like mine (MFS Investment Management) all refuse to pay for the credit rating agencies, and they [the agencies] are just paid by the small and middle-sized investors?"

His proposed solution: Since it's not feasible to have investors pay, a third party should be interposed -- for only one day. For example, when large structured financings occur, the SEC would appoint a neutral arbitrator whose job for that day would be to interview all the credit rating agencies and pick one on the basis of who would do the best job for investors. From then on, the issuer would still pay.

"It's like a public good," Pozen said. "But it's like a one-day consulting fee to make sure that the choice would be made on an objective basis. It's not perfect, but it goes after the main problem, which is forum shopping."

What do you think? Is this a good way to revive the securitization market? Give us your take in the comments section below!

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