Clawbacks and other forms of “keeping skin in the game” won’t work, because by the time the loan defaults, the originators/servicers will have made their money and can simply file BK or go out of business.
I think you misunderstand what is meant by “keeping skin in the game”. What it really means is that the originators will not be able to completely sell of the structured debt/CDO. The originators would have to retain a percentage for a specific number of years (probably past child death period – about 3 years). It would be possible to structure it such that any gain they would have from origination etc would be offset by the losses in the retained portion should a specified percentage of loans go bad. Going out of business would not give them a way around the losses. If I originate $100mil on loans and the origination fees are $5mil and I have to retain 20% of loans I originate ($20mil).. if 25% of the loans go bad, I am out my profit that I made from originations because my retained portion lost 25% or $5mil.
Quite frankly, I don’t think we should have originators or servicers in the process at all, and there should be full transparency from the origination point to the final lender. We should have one internet site where (final) lenders list their rates and product types, and customers can choose from there.
This would mean that banks would rule almost all of the originations.. and they were part of the problem. In several cases, the banks collateralized loans that they felt were questionable and sold them off as investments while retaining the best loans.
I do know that the originators would really get upset about having to ‘retain’ a percentage of loans that they originate. They just want to originate, turn and burn. For the next cycle of originations, they would need to find additional $20mil to cover the amount that would have been recovered on the sale of all of the CDO.
