Aftermarket Needed for Bank Loans

A secondary-market facility for all bank loans would be an excellent way to give much-needed credit to the U.S. economy without a great amount of further risk in banks' loan portfolios.

Such an entity should be run on banking safety and soundness principles and provide for examination procedures analogous to those used for mortgage loans traded in the already existing secondary market.

If a special bank or entity were to be created, management and a regulator would have to be picked. The latter decision would require considering whether the new entity should have its rules made by an existing agency or a newly created entity similar to Fannie Mae or Ginnie Mae.

Information Disclosure

Difficult problems are involved in getting a bank to disclose information about its loan receivables to a secondary-market participant -- without violating confidentiality or disclosing trade secrets. Yet enough data must be disclosed to let it package and reoffer such loans in the market.

Nevertheless, loans extended by a bank meant for a special secondary market could be granted on the basis of meeting information, performance, collateral, and guaranty requirements geared to packaging needs.

Granting such loans would be more involved and time-consuming for the borrower than commercial loans have been. The lending process would also involve more safeguards and giving of information. At least, however, credit would flow more reliably and steadily.

Shifting credit risk beyond a small group of shareholders and the lending bank's depositors to the wider group of ultimate purchaser-investors in loans on the secondary market spreads the risk and facilitates new financing.

Attracting Investors

Bundled non-home-mortgage loans have been marketed in the form of asset-backed securities, but the Securities and Exchange Commission issues involved in this forum must be considered. An organization similar to Fannie Mae or Ginnie Mae might present fewer such issues and be more attractive to the investor.

A venture capital fund should be created for this purpose, if no federal or state money is available. Credit should be standardized and conformed to rules like those of Freddie Mac, Fannie Mae, and Ginnie Mae. Even if such a secondary market is generated with the help of a venture capital fund separate from government, permission should be sought to coordinate these entities' rules and safety and soundness procedures.

Thus, though no taxpayer dollars would be involved, the imprimatur conferred by standards that conform with those agencies' could help improve the creditworthiness of loans meeting the program's guidelines and reduce the credit risks to lenders.

The result could be an expanded base for funding enterprises in this country, and that could maintain a strong America.

Loans under such a regime could be standardized for resale with guidelines and limits analogous to those of present secondary-market entities.

Borrowers that meet the most stringent lending guidelines could get more attractive repayment packages in the form of lower interest rates, fewer points, less loan insurance, and less onerous documentation and periodic reporting requirements.

Similarly, loans with a higher level of collateralization could get more attractive credit terms. These standardized loans conforming to specific, risk-minimizing requirements and procedures would probably be more marketable.

Questions of retroactively applied rules and liability for later standards would have to be answered before such a market could be created, however.

A secondary market in all loans could provide a standardized checklist of loan documentation that could supplement or replace less than adequate loan procedures now used in many banks. Thereby, it could improve overall loan portfolio quality of a bank's asset base.

Loan-Protection Insurance

Loans that do not meet those standards could be protected by a mortgage-protection type of insurance and by higher interest rates to reflect total cost of funds, as well as the greater risk of such credits. Loans covered could have mandatory insurance similar to the MPI type, depending on the quality and value of appraised collateral, at percentage levels of the outstanding loan balance. For example, MPI covers home mortgage loans with less than 20% down payment.

Packaging the loans and hiring employees to do so would present logistical problems, but those expenses could be passed on to the customer in the form of a standardized packaging fee. A customer who would otherwise be excluded from the loan market would probably be willing to pay such a fee.

Additionally, a secondary market under an agency or entity could be built in the form of several tiers of ascending order of risk or be divided into conforming or nonconforming categories, with appropriate differentiated cost-of-funds schedules for the categories. Loans conforming to the highest standard would have one cost-of-funds package; a loan meeting a second tier of standards would have a higher cost-of-funds basis, and a nonconforming loan would have an even more stringent cost-of-funds basis and loan-contract provisions.

A secondary-market facility for loans could be created for credits in the domestic and foreign markets with subareas for different types of loan.

Helping Finance Exports

A foreign loan secondary market facility could take up the portion of loans by U.S. banks that remain uncovered by multinational organizations or organizations backed by the full faith and credit of the United States.

This would help maintain credit availability in areas of business investment and activity and help finance exports.

A bank could sell many loans it might not want to retain for reasons of risk, concentration, or laws and regulations.

This secondary-market facility could be particularly helpful for uncovered portions of loans to joint ventures and for other investments in Eastern Europe and the former constituents of the Soviet Union.

For the sake of this country's stability, it is imperative to keep open the flow of money and the ability to further commerce through all types of prudently made loans.

A carefully thought out and regulated secondary market for all loans -- if it is formulated, based, and regulated according to longstanding and well-tried procedures -- has a good chance to succeed and help our country.

The best protection of the liberties of this country is a widely based middle class made up of the majority of people, with a wide margin of "almost-middle" lower-income people and mildly wealthy people. That would contrast with a large, nearly destitute underclass, small middle class, and even smaller but fabulously wealthy upper class.

In order to create as much well-being and consequent social stability as possible, it is necessary to provide a secondary market for all loans that would widen the possibility of investment and growth in our country. This, in turn, would strengthen our people.

Ms. Woody is a lawyer and adjunct professor of law at Georgetown University Law Center.

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