Part of Dodd-Frank required that the Federal Reserve Board publish a report on the risk retention of lenders in securitizations.
Ostensibly, the report is to be used to foist more risk retention on issuers. The only thing is the report published by the Fed last week seems to nod to leaving things alone.
[Full Disclosure: Because of my involvement in the auto finance industry, I submitted a letter on risk retention in auto ABS on request of the Fed. See it here.]
Largely, the report outlines how risk retention works in securitizations — and accurately, in my view. Then, the Fed offers fully eight factors to consider for the author of any forthcoming new rules on risk retention. They are:
- Consider the specific incentive alignment problems to be addressed by each credit risk retention requirement established under the jointly prescribed rules.
- Consider the economics of asset classes and securitization structure in designing credit risk retention requirements.
- Consider the potential effect of credit risk retention requirements on the capacity of smaller market participants to comply and remain active in the securitization market.
- Consider the potential for other incentive alignment mechanisms to function as either an alternative or a complement to mandated credit risk retention.
- Consider the interaction of credit risk retention with both accounting treatment and regulatory capital requirements.
- Consider credit risk retention requirements in the context of all the rulemakings required under the Dodd–Frank Act, some of which might magnify the effect of, or influence, the optimal form of credit risk retention requirements.
- Consider that investors may appropriately demand that originators and securitizers hold alternate forms of risk retention beyond that required by the credit risk retention regulations.
- Consider that capital markets are, and should remain, dynamic, and thus periodic adjustments to any credit risk retention requirement may be necessary to ensure that the requirements remain effective over the longer term, and do not provide undue incentives to move intermediation into other venues where such requirements are less stringent or may not apply.
To my mind, anyone writing a new rule is going to have a tough time shoehorning the changes within the above parameters. Is this going to guarantee that current risk retention rules will remain in place? Of course not. But in the world of regulators, this report amounts to a roadblock, and I can hear the sigh from West Street loud and clear.
H JJ, i would not think the Fed would oppose anything the bigFinancials want to do to line their own pockets and if others are negatively impacted, the Fed only goes about dealing with that with some drama and stylized, surreal way. What it comes to is there are laws such as the Federal Rules of Evidence, and not even the judges may violate these. That property’s paper has been used, hypothicated many times over while it’s been encumbered actually also violates rules, but in securitizations this has been the practice. Years ago, I’d heard someone speak who had done the legal power lifing on the problems when a borrower such as a home owner or someone with credit card debt has to go to court and the original signatory of counterparty fails to show and the paper was sold, but neither the paper nor the original signatory appear in court. This gives the debter the victory under the federal rules of evidence unless the judge gives the accuser another chance to produce the original signatory and the promissory note. Ginnie Mae was the first party which would buy or securitize the paper because the underwriting standards or the full government backing on that paper was not going to produce 1. court for cure process or 2. default or cure without gov backing. fannie and freddie picked up the practice and recall their underwriting standards were ‘A’ Paper, “prime” etc which would virtually never default or end up in court for cure proceedings. Most home owners dont realize their mortgage note was roled into a financing of some sort and unless the original rules hold up, it speaks very poorly about the erosion in our legal and institutional framework that leaves property owership at such capricious risk. As i’ve said, I’ve listed to things like CRA where the interaction between the bigfinancials’ cra senior officers and practices and the fed’s involvement at ‘policing’ cra, gave me the take away i was listening to the contemporary version of feudalism with the banks as the new lords of the manner. no true industrial development is encouraaged and the definitions for industrial and economic/commercial development are very limited and marginal. nothing really very good for the economy that isnt in some way a state organ, or a state subsidized party/participant.
Most of what happened was done on purpose by people who studied the system(s) knew the flaws and did anything possible to exploit the problems.
But the Fed will not withdraw support for an operating practice that had been very lucrative for the bigFinancials while also giving them some flexibility and liquidity. And management has been significantly benefitted by the operating strategy. The only way the fed would back away is if another operating strategy that suits the same needs were to surface as the ‘alternative’.