As I noted in my earlier treatise post, the Administration has proposed requiring all originators to keep a stake in each asset securitization, to ensure that they have “skin in the game.” In particular, the Administration proposes requiring retention of a 5% stake, and would further mandate that the stake remain unhedged.
The last bit troubles Felix Salmon, who seems to think that makes CFOs life difficult. Perhaps, but should we care? In particular, there clearly is some tension between this proposal and traditional risk management. But at present, originators can use CDS to give themselves a zero or even negative stake in the outcome of the securitization. In such a world — and that’s the world we’ll return to if we simply restart the securitization market without change — the downward spiral of asset quality I described in my prior post in essentially unstoppable.
Sure investors will be “smart” now, and they won’t buy low quality assets with the same mania, but individual investor moderation does only little to address the systemic issues that come from excessive securitization. Only an unhedged originator stake can correctly align incentives. I doubt 5% is a sufficiently large stake; but it’s a start, indeed any number greater than zero is a move in the right direction.
Comments
2 responses to “A Further Thought on Securitization Regulation”
They’ll find a way around it. They always find a way around it. Securitization will only ever be used by CFO’s who don’t know how to cheat the system, leading to another recession! Don’t mean to be doom and gloom, but we don’t seem to have learned much after the last debacle.
Professor, please forgive me if you’ve covered this somewhere in the past and just point me in the right direction.
There has been a growing suspicion among some of the more knowledgeable and dedicated Mortgage Servicing Fraud victims that there has been some collusion between note holders, parent corporations and the servicers that they owned with regard to CDO/CDS play. I’m admittedly in waaaay over my head when I try to have any kind of even remotely intelligent conversation about CDO/CDS but the premise that has been forming is that the note holders and/or parent corps place their “bets” on particular tranches of RMBS on one side of the fence and then turn the servicers loose on the other side in order to deliberately tank that particular tranche.
To my extremely simple way of thinking about this, it seems to make sense. It appears to be a win/win for both sides as servicers get to jack fees through the roof and, in many cases, pocket the physical property and any equity as the dot on the “I” and the bets against the tranches pay off on the other side.
Now, in a “perfect storm” scenario note holder tranches/associates get to pocket claims against “note insurance” for any non-performing loans so there’s recoupment #1. #2 would be claims against any existing pmi should that exist. #3 is actual procurement of the asset through the foreclosure process (and any accumulated equity). #4 would be any deficiency judgments against the borrower. I’m thinking particularly, but not exclusively, about Florida’s $100 auctions here. #5 is the re-sale of the property at FMV. Until the bubble burst it was conceivable that REO properties would recoup 100%+ on any arrearage. #6 goes to the larger picture – the revenue generated by the “float” in any given tranche. I can only imagine that even 20 days of interest on $100 million in monthly payments adds up – especially if a servicer can multiply that by 2,3 or 5000x depending on their individual portfolios. I’m sure that #7 could be considered any associated tax advantages that I have absolutely no reason to know about.
Could hedged CDO/CDS bets against tranches be considered #8?
My OVERALL thought here, is that, based on a $100,000 note (for easy math) it is conceivable that as much as $600k (up to #6) can be recouped on the individual note and then the individual note helps contribute to the larger picture with #7 and possibly #8…
Am I completely out of my gourd here with this?