Re-Remics? Really?

The Wall Street Journal today has an interesting article about a new type of security that it claims is taking Wall Street by storm. It's called a "re-remic," which stands for resecuritization of real-estate mortgage investment conduits. Got it? Let me explain.

WSJ actually provides a pretty decent diagram explaining how these work. The idea, however, is pretty straightforward. You take a bunch of real-estate assets that were already rated and re-pool them to structure different securities with a different rating structure:

Re-Remic WSJ.gif

So what's the point? Well the purpose is two-fold: one is to require their holders to maintain less capital than before. The other is to sell of some of their toxic real-estate securities.

WSJ explains the first reason:

A hypothetical example cited in research by Barclays Capital said that a $100 million asset that required $2 million in capital at a triple-A rating may require $35 million if downgraded to double-B-minus. At triple-C, the capital requirement might rise to 100%, or $100 million.

In a re-remic, three-fourths of the same asset may regain a triple-A rating, requiring just $1.5 million in capital, Barclays said. The remaining one-quarter may require 100% capital, but the total capital requirement would fall to $26.5 million.

In other words, the new structure utilizes additional collateral cushion (consisting of the worst stuff) for the higher-rated securities to end up with lower capital requirements. Pretty slick, as the same securities suddenly result in the banks being required to hold less capital to back them up.

As for the second reason:

Wall Street bankers and analysts said a minority of re-remics, perhaps as little as 10% to 30%, are aimed at helping firms like insurers manage capital requirements. The general goal, as one banker put it, is to help "create buyers for orphan securities that otherwise would have languished."

Certainly banks are interested in moving some of these securities. This new structure creates bonds that investors are more attracted to -- though I can't really imagine why. I would think investors should have learned their lesson by now about buying mortgage-related securities that they probably don't fully understand. Shows how much I know.

So is it okay for banks to do this sort of thing? You can decide that for yourself. It does seem a little bit preposterous that the same securities could be sliced and diced to require less capital. But I understand how that's possible, given the math. So in a strange way, it makes sense. What I would expect, however, is that a backlash to sneaky structuring like this might produce a call for streamlined accounting changes resulting in similar capital requirements for real-estate assets no matter how you rearrange securities.

Update: Just got a call in response to this post from Rep. Dennis Kucinich's (D-OH) office. They forwarded me a letter he sent to the Treasury today to bring this issue to its attention. He's concerned that many of these re-remics are outside of the jurisdiction of the SEC.