With the administration set to unveil plans for regulating the securitization process (details of which are available here), it's worth taking a look back at how already-regulated banks performed during the subprime boom.
In a paper put out earlier this year, a group of economists compared the quality of loans originated by regulated vs. non-regulated mortgage lenders. In the former group were megabanks and thrifts while in the latter were independent lenders like the now-defunct Ameriquest.
Surprisingly, the regulated sector originated loans that were of worse quality than the non-regulated sector. This would likely mean that independent lenders did a better job screening borrowers than regulated banks. How can this be? Part of the answer may be that since independent lenders had a much smaller capital cushion to fall back on, their incentives to screen were much stronger. In other words, market forces may have been more effective than regulation.
But it wasn't necessarily the existence of regulation that caused laxer screening by banks, but the lack of the right kinds of regulation, the study's authors suggest:
...appropriate incentives for originators (brokers) may help to attenuate the moral hazard problem. For instance, regulation that requires brokers to have ‘skin in the game’ does indeed help curb the moral hazard problem. Pushing this further, one can argue that policies which require originators to hold some risk have the potential to reduce the moral hazard problem.
So it's a welcome sign to see that part of the administration's plans (which has received plenty of criticism already) is indeed to force originators to hold on to some of the risk in the loans they make.