Administration Proposal to Address Severely Damaged ABS Market
June 16th, 2009 | 
Author: The Obama Administration revealed a proposal yesterday that is designed to safeguard the asset-backed securities (ABS) market that played such a significant role in causing our current economic crisis. The purposes of the reforms are to encourage responsible lending and lower the risks of ABSs by forcing the sellers to share in the risk of the securities and provide more information to investors.
Under the proposal, sellers of asset-backed securities would have to retain at least five percent of the risk of the loan package, and they would be paid gradually to allow for a reduction in payments if loans go into default.
The proposal also calls for increased disclosure of the contents of each security, and would require rating agencies to make a clear distinction between the asset-backed ratings, and those assigned to other forms of debt. Additionally, the rating agencies would have to disclose more information about their rating methodologies and conflicts of interest.
According to the Washington Post:
The administration’s proposal is not just an attempt to clean up the securitization market. The goal is also to help revive that market, which has seen almost no activity in the last year.
That goal was welcomed by industry groups, even as they cautioned that some details needed further examination.
"There may be parts of this proposal where the industry disagrees, but we pledge to work closely with the administration and global policymakers on this vital topic," said George Miller, executive director of the American Securitization Forum.[1]
An interesting component of the proposal is that it would prohibit banks from hedging their retained risk in the asset-backed securities. According to the Washington Post:
But some officials and financial experts still are skeptical about the requirement. They note that lenders often kept a piece of their securitizations during the housing boom, either as a desirable investment or because it could not be sold. This retained risk was a key source of the losses that crippled Citigroup and other banks.[2]
I can appreciate that maintaining “skin in the game” with regards to securitizing loans should lead to more careful loan underwriting, but that retention will also expose the banks to greater risk. I believe that the originators of asset-backed securities grossly misjudged the risks of the instruments that they were creating because they were counting on diversification and a rising real estate market to mitigate those risks. If they have learned their lessons from this crisis, which I believe they have, then they should be better able to manage this risk, and the proposal could help rebuild confidence in the ABS market.
What are your thoughts?
[1] Binyamin Appelbaum, “Regulatory Revamp Targets Securities at Heart of Crisis,” The Washington Post, June 16, 2009.
[2] Ibid.
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I have 22 years of securities industry experience and am supportive of the proposals put forth by the Administration. As someone who has not been directly involved in the Risk/Compliance area, my attitude is more investor based with the added benefit of understanding the securities industry much better than the average consumer.
I believe that the securities industry should be regulated and that the larger firms need to have skin in the game to balance their products with a healthy level of profitability but not at the expense of risk that will jeopardize not only the firm but the entire industry as we are experiencing now. I do not believe that anyone in the industry including the firms and the regulators saw what was coming because everyone was too involved in their own goals to see the forest burning through the first layer of bright green trees. For that reason we need high level oversight of groundrules and policies that will not allow that environment to be created again. I agree that the industry has learned a lesson, but I also believe that without rules and regulations, we will put ourselves at risk for this happening again if the industry again returns to profit potential that overshadows the risks.