How will financial institutions make money now that the securitization food chain is broken?

Let’s consider in more detail this loan origination and securitization chain for residential mortgages, commercial real estate mortgages and leveraged loans financing LBOs…

Think of this fee generation process along this long food chain: it started with mortgage brokers whose income/fee was based on maximizing the volume of mortgages being generated and approved; they had all the incentive to ignore the creditworthiness of the borrowers and maximize mortgage volume and their personal income. The fee generation machine then passed to the bank originating the mortgage that was packaging these mortgages into MBS and thus making a fee in this process and transferring the risk down the line to someone else; again the bank care little about the quality of it own origination as it was transferring the credit risk. The fee generation machine included the home appraisers who were being paid by the mortgage originators and had all the incentive to inflate the appraised value of the home to get more and more fees and more and more business; this fee machine also included the mortgage servicers who got fat fees from servicing the mortgages and getting even fatter fees when the hapless borrower falls behind in its mortgage payments and who thus have no incentive to prevent foreclosure. The securitization food chain continued with the investment banks slicing and dicing the MBS into the equity, mezzanine and senior tranches of CDOs and making fat fees on that process and on managing such CDOs. The fees compounded when the CDOs became CDOs of CDO (CDO squared) and CDOs of CDOs of CDOs (CDO cubed). Then the rating agencies that blessed these CDOs chains and tranches with AAA rating were getting their fat fees (and most of their profits) from rating – or better misrating - these toxic products and converting – via voodoo magic –bundles of BBB subprime mortgages into AAA rated tranches of CDOs. Along this fee generation machine the monoline insurers were making fat fees insuring these toxic instruments and providing additional AAA blessing on this garbage and trash. And finally if this garbage of CDOs (or CDOs cubed) was not fully distributed to clueless and greedy investors banks created off-balance sheet SIVs and conduits that would buy the leftover trash that no investor wanted to touch and repackaged it into structures that were financed with the most short term ABCP; these SIVs were then blessed with credit enhancement and guarantees of liquidity lines from the banks that made them de facto on balance sheet items even if they were de jure off balance sheet; but there were extra fat fees to be made from managing this toxic SIVs and conduits and thus the fee generation machine kept on rolling.

In this securitization food chain – or better scam - every institution made a fee and transferred the credit risk down the line. Then no wonder the credit risk was transferred to those who were the least able to understand it: somehow greedy and clueless investors searching for yield bought tranches of instruments – CDO or CDO cubed – that were new, exotic, complex, illiquid, marked-to-model rather than marked-to-market and misrated by the rating agencies. Who could then ever be able to correctly price or value a CDO cubed? And for all the talk about the benefits of financial innovation what was the social value of a CDO cubed? There was indeed zero social value in this type of financial innovation that is closer to a con game than to a financial product of any use.

So now that this credit house of cards has collapsed this securitization food chain is effectively dead and the process of generating fees - and thus profits – for financial institutions is severely hampered: fees are collapsing for mortgage brokers, home appraisers, mortgage originators, mortgage servicers, CDO managers, monoline insurers, rating agencies, SIV managers and so on.

So how will all these financial institutions generate revenues and profits now that this effective scam has mostly collapsed?

Sharks gotta keep swimming, right? And there's at least one very, very obvious answer: