Insurance industry White Paper identifies Marketcore as solution for valuing RMBS

Financing Home Ownership
From Land Grants to Mortgage-Backed Securities
Public Policy, Financial Innovations and Crises

In the view of Eric Nordman, Editor:

Concluding Remarks

“David M. Rowe discusses the complexity and challenges of risk assessment of complex financial products, including RMBS. The heterogeneity of risk and performance in the underlying assets further complicates the picture. Thus, he recommends greater uniformity among underlying financial instruments to improve homogeneity. He observes that sellers have no interest in being more transparent as they perceive a competitive advantage created by information asymmetries. Mr. Rowe correctly observes that technology is now available that is capable of handling the volume of information needed to counter the information asymmetry advantage of deal originators. However, the technology will only be developed if there is a call to arms by ‘an alliance of buyers, regulators and the general public.’ He suggests market-driven transparency as the answer. Mr. Rowe mentions an intellectual property company, Marketcore, as a thought leader in this area.

“Mr. Rowe’s vision would include an electronic transaction system to capture initial RMBS transactions along with any subsequent structural details. He favors a private sector, rather than government solution and his section identifies important partners necessary to build such a system. He encourages the use of Marketcore’s Transaction Credits™ model to encourage system use by market participants. This key feature would be ‘the tool used to provide incentives to originators, aggregators and investors to encourage them to use the system and to report events related to the value of underlying mortgages.’ If a regulator portal were added, then the multiple eyes of state insurance regulators would assist with keeping all parties honest and provide a valuable risk valuation tool for all financial regulators.”

“…Hopefully this paper has presented some possibilities worth pursuing to reach a workable solution that improves market performance through increased standardization of financial instruments, improved transparency and more meaningful, and perhaps more timely, disclosure of information to investors, regulators and the general public. True competition works best when information asymmetries are minimized or eliminated. Transparency to regulators is a must.”

In the view of David M. Rowe, author of The U.S. Residential Finance Market – The Road to Recovery:

Market-driven Transparency

“How could a detailed, up-to-date and readily accessible database with all relevant structural details of the underlying collateral become a standard feature of the markets for complex financial products? As Adam Smith would have said, we will not accomplish this by appealing to “the benevolence of the butcher, the brewer” or the investment banker. The dramatic improvement in transparency that technology now makes possible will only be fully realized and effectively maintained through a combination of regulatory coercion and appeals to self- interest.

“In additional to regulatory pressure, establishing such a system will require several things. The first is a well-heeled insurgent organization with little or no stake in the current market arrangements to underwrite the technical development of such a system. Second it will require participation commitments from a core group of buy-side firms who would stand to benefit from the greater transparency, lower risk and sharper pricing that such a system would create. Finally, it will require commitment from some aspiring second-tier sell-side firms who would stand to benefit from a first mover advantage by being an early participant in such a transformative arrangement and the big increases in trading volume it would create. A major technology firm also must be involved. This could be in the form of a purely arm’s length vendor who is paid for the system’s development or as an equity partner or some combination of the two.

“Essential to the success of such an arrangement will be assuring prompt and accurate updates to the information and establishing sufficient trading volume and associated liquidity to insure investors that they can transact in reasonable volume without significant impact on prevailing prices. Marketcore [1], an intellectual property company, is a key innovator in this area and has developed foundational technology for creating healthy and transparent markets. One of Marketcore’s patented solutions [2] is centered on the provision of time-limited Transaction Credits™ to liquidity providers as well as those responsible for maintaining the continuous updating of the underlying data. These credits provide either discounts on future trades or privileged access to the uniquely valuable detailed data such a system makes available. Their terms of use also can be adjusted to drive business volume toward newly introduced products or areas where the exchange desires to promote market interest and liquidity. They also could be traded for cash as desired. In addition to liquidity providers, transaction credits can be allocated to originators and servicers as incentives for prompt and accurate updates to the detailed status information in the database.

“In essence, Marketcore’s patented technology leverages the most valuable commodity such a system creates, namely the consistently organized detailed data on the complex securities being traded, to solve the key challenges that such a new trading system faces, namely building reliable liquidity and assuring that the data are maintained in a timely and accurate fashion. Once established, the usage pattern of Marketcore’s Transaction Credits™ becomes a valuable source of market intelligence. Such usage data can offer valuable insights into evolving market interest and areas where increased analytical attention may indicate emerging market concern about potential risk.

“Of all the financial markets operating today, the housing finance market is among those most in need of Marketcore’s innovation and also the most likely place for it to succeed. Many of the same financial institutions that would instinctively oppose this innovation (because it undermines the advantages they gain as market-makers from the prevailing level of opacity) also have a need to unburden themselves of existing mortgage assets. Revival of the residential mortgage CDO market would offer them a means to draw new sources of capital into this arena on a fully transparent and well informed basis. There is simply no way these investors will return to this market until such transparency is clearly available. As the old saying goes, “Fool me once, shame on you. Fool me twice, shame on me.” Furthermore, if established on a firm foundation of currently updated information and stable incentives, a revived residential finance market would provide long-term investors with a valuable alternative that currently is simply not viable.

“The stars are well aligned to support such a development. One indication of this is that the first such transformation is actually in initial operation. LexisNexis has collaborated with the Council of Insurance Agents and Brokers (CIAB) and Marketcore to create the LexisNexis Insurance Exchange [3]. It is initially focused on property and casualty policies but it has plans to expand into life and health as well as reinsurance. Since a similar mechanism would be equally applicable to various heterogeneous credit and derivative instruments, this might just be the beginning of a much broader market transformation.

“If this transformation materializes, it will result in more robust and resilient credit markets. Such a structure would allow a wide variety of analysts to track and evaluate these securities based on reliable empirical data rather than on marketing hype or on complex top-down analytic techniques that are out of touch with the actual underlying collateral. In the end, such a structure would provide many opportunities even for those sell-side firms that will resist it the most. A more transparent market, built on access to reliable and up-to-date detailed data, will generate demand for new and innovative hedging instruments that these firms are so well equipped to provide. Given the broad social benefits that flow from more efficient allocation of savings into real investments with the best return, we all should work to realize this vision.”

[1] See http://www.marketcore.com
[2] Marketcore’s issued patents include US Patent Nos. 6594635, 7742966 and 8027909.
[3] See http://www.businessinsurance.com/article/20120101/NEWS04/301019988
http://blogs.lexisnexis.com/insuranceexchange/2012/02/10/getting-left-behind-is-closer-than-you-think

Click here to download the Marketcore press release

Click here to download the full NAIC white paper

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