CHARLOTTE, N.C. -- Protecting credit markets from another meltdown requires sound underwriting standards and a requirement that issuers have "skin in the game," says the chief risk officer of JPMorgan Chase ( JPM). "All the other aspects of it are nice to have, (but) the most important thing is sound underwriting standards, " Barry Zubrow said Thursday, in an interview following a panel discussion at the Federal Reserve Bank of Richmond's Credit Markets Symposium. "If not, we will always find some way to get back into the next crisis." The standards are basic: proper documentation, lending against proper value, certainty that borrowers are truthful, and a basic review of credit standards, Zubrow said. Regulators must enforce the standards, not only for banks, but also for mortgage brokers. In the wake of the crisis, he said, investors are more discerning, and, for JPMorgan, "the product we originate today is a much better product." At the same time, he said, regulation must be sufficiently selective, "so as to not aggregate bad times and to not promote good times." In the words of University of Chicago finance professor Raghuram Rajan, another speaker, regulation must also be "cycle proof (because) regulation set against the cycle will not stand." In bad times, he said, regulation can erode under pressure from an industry that feels constrained. As for requiring skin in the game, Zubrow said, "Something needs to be adopted on a global scale in the simplest form whenever a dealer or bank organizes a securitization pool, (requiring) them to retain some percentage. There has to be coordinated regulation to make that happen. But no one expects it to be a replacement prophylactic for good underwriting practices."
Curtis Arledge, managing director and co-head of U.S. Fixed Income at BlackRock ( BLK), also advocated improved underwriting standards. He said securitization markets became "the ultimate lender to the U.S. economy in many asset classes," particularly consumer lending. "Securitization is not an asset class," he noted. "It is a machine," where putting in bad assets, originated after inadequate underwriting, results in bad securities. Increased transparency is also enhancing market quality, Arledge said, adding: "We want transparency all the way back to the borrower." He praised the recent effort by General Electric ( GE) to disclose information about GE Capital during a six-hour conference call. "What GE realized is they have lost their access to capital," he said. "Banks had provided a really cheap revolver, but no longer could, and they needed the market to understand what they were." In the past, he said, if investors had demanded such disclosure, GE "would have said, 'We don't need to show you -- there is so much capital.' " The reason is that, "It's a bull market phenomenon to invest in things you don't really understand." Such thinking reflects the euphoria created by bull markets. Many parties are to blame for the current crisis, said Rajan, including rating agencies, politicians who deregulated banking, bankers, regulators and the average citizen. But "they all had a willing accomplice, and that was the (economic) cycle," he said. "In the midst of a boom, who is willing to stand against the boom?" Typically, he said, regulations are imposed after a boom has gone bust, then removed because they come to be seen as too draconian -- limiting an institution's size is an example. For institutions considered too big to fail, suitable regulations would include a requirement to purchase collateralized insurance, he said.
Additionally, such institutions would have to devise shutdown plans and to theoretically dissolve themselves for a weekend to ensure the plans' viability. "If they are forced to think about such a plan, it would reduce their incentive to become more complex," Rajan said.