provide for the originator to repurchase loans if these requirements are not met.  However, when there is a chain of sales from one purchaser to another before a loan ends up in a securitization, investors may find it hard to enforce these obligations.  Similarly, borrowers who have been victimized by an originator may have nowhere to go to seek redress if the company that originated their loan goes out of business.  Some in Congress are proposing “assignee liability” as a solution to this problem.  Assignee liability, however, may create risks for investors and intermediaries that they are unable to assess. 

As an alternative to assignee liability, an updated form of representations and warranties – an origination certificate – would be a better solution.  An origination certificate would be a guaranty or surety bond issued by the originating lender and broker.  The certificate would verify that the loan was originated in accordance with law, that the underwriting data was accurate, and that the loan met all required underwriting requirements.  This certificate would be backed by a guarantee from the originating firm or other financially responsible company.

The origination certificate would travel with the loan, over the life of the loan.  By clearly tying the loan to its originators, the market would gain a better pathway to measure the performance of originators and a better means of enforcing violations.  Borrowers would also have a clear understanding of whom to approach for redress of misrepresentations and fraud.

While risk arising from economic uncertainty can be managed and hedged over the life of the loan, the risks associated with poor underwriting and fraud can only be addressed at the initiation of the loan.  Such risks should not be transferred to subsequent investors, but should be borne by those who are responsible for the origination process.

Second, the current senior/subordinated structure should be revised, simplified or, perhaps, even abandoned. The beauty of the senior/subordinated structure is that the credit quality of the senior classes is based on the quality of the underlying assets, not on the guaranty of any third party.  In principle, the diversity of loans in a pool should create a better quality guaranty than even a highly rated corporate guarantor.