Why Does The Fed Ignore Fraud?

Today there was an article discussing in a not yet published paper the ideas of two Fed economists, Wayne Passmore and Diana Hancock, and how they would like to create an FDIC-like entity to insure Asset-Backed Securities (ABS).

I think it admirable that they are trying to come up with ideas that will help revive the asset backed securitisation markets, but I believe they are focusing on the wrong problem.

Anyone who has ever been involved with the securitisation market, with the exception of black-box CDO's will tell you that if you have the patience you can go through every asset in the portfolio and make a rational decision as to the credit-worthiness of each underlying asset.

Unless there is fraud.

Most investors were either too lazy, or too greedy to do their own homework and so were "happy" to have the ratings agencies and the financial institutions offering the product provide the documentation ascertaining the credit quality of the security in question.

Of course if the purchasers are not willing-or claim to be unqualified to do the analysis themselves than it is also quite possible that they would not appreciate the true meaning of the disclaimers attached to every opinion, be they from a rating agency or a bank/broker dealer.

If a purchaser is truly not in the position to do the required analysis and they are acting as a fiduciary then they are failing in their mandate. If they are capable, but are too lazy to do the work required, then they are failing as a fiduciary, as well as deluding themselves.

The fact is that the majority of the Asset-Backed Securities which were either downgraded or outright failed were rife with fraud, beginning with the loan documentation, and in my opinion, amplified by the complicity of the rating agencies who applied statistical analysis in place of "traditional" credit analysis to determine the ratings they were granting.

So now we have a couple of Fed economists who have decided that the problem with the ABS market was the lack of an FDIC-like insurance fund to insure the credit quality of the ABS issues?

Try instead to have the regulators inspect the documentation on the underlying assets before they are put into a GSE. Change the wording of the rating agency mandate to include some language which holds them more to account, and prosecute fraud aggressively.

And reintroduce "moral hazard".