What Should Securitization Reform Look Like?
As I type this, I am sitting through another session at the American Securitization Forum. This one seeks to investigate the shape that policy reforms should take. The session is only an hour long, but given the broad financial regulation push in Washington, it could last for weeks. Luckily, there are several more targeted sessions over the next two days. This panel explained changes they think we will see, and what they hoped we would see, in broad strokes. One thing is clear: they want something a little different from what we're seeing in Congress thus far.
The industry panelists all agree that some regulatory reform is justified and needed. But they aren't all on board with all of the suggestions that policymakers have made concerning what those changes should be. The prevailing belief, found in both the House and Senate versions of financial reform, is that banks and issuers need to keep some "skin in the game." These provisions seek to have those who create securitizations hold some of the risk. The idea is that banks would have to eat a little of what they cook, which policymakers believe will result in less poisonous securities offered to the public.
Panelists took a few issues with this position. One problem was the across-the-board nature of current proposals, where issuers would be required to hold onto something like 5% of the risk for any securitization deal they create. Hal Scott, a Harvard Business School Professor on the panel, thinks this regulatory proposal would function better if the retention requirements were tailored to each specific deal. Some deals are riskier than others, due to their underlying assets and/or structures.
Scott voiced another worry about this proposal. He pointed out that it conflicts with the other broad regulatory goal of making safer banks through higher capital requirements. Banks required to hold additional risk from the securitizations they create will be less safe, which is exactly what regulation seeks to avoid.
One investor on the panel, William Moliski of Redwood Trust, Inc., also wondered what the portion of a securitization held back is supposed to do. Is it to cover representations and warranties violations? He wonders who will have access to that piece of the deal if things go bad, and under what circumstances. If it is the first loss piece, then he worries about what this means for consumers. If banks have to take a first loss on all securitizations, then he fears that there will be some consumers that are permanently shut out from loans. One of the benefits of securitization is diversification of loan risk, which generally spreads losses over the entire pool, making them easier to stomach.
The official ASF position, however, is that the entire idea of risk retention is misguided. While the Forum "fervently" supports the idea of aligning the interests of investors and issuers, it fears that risk retention could interfere with securitization and reduce volumes. That could conflict with the very essence of securitization, which is the ability for issuers to obtain funding and to create more loans.
Instead, what ASF and the panelists are in clear favor of is greater transparency. They believe that could come through better disclosure and modified reps and warranties. Scott suggested that disclosure reform for publicly issued securities should be mandatory and not just a best practice suggestion. This could even extend to privately issued securities.
Moliski also addressed transparency. He is pleased additional information is being provided these days, but he wants even more. There is some data that is considered private or sensitive, but that information would be very helpful for investors to use in their analysis. He named the addresses of mortgage borrowers as an example. He said transparency only gets you so far without more detailed information.
(Written around 10:45am, posted later due to technical difficulties!)