Saturday, June 27, 2009

Proposed securitization rules

I see that the administration has come to some roughly similar conclusions as me, in regards to reducing incentives to willy-nilly securitize crappy loans. Have they achieved the appropriate balance between efficiency of capital, and systemic risk reduction and system redundancy?

According to reports, the administration intends to reduce the vile habit of bankers throwing crappy loans through to unsuspecting investors (imagine, investors EXPECTING banks to have performed some sort of reasonable underwriting in the first place).

It appears that the administration intends to force the underwriting firm to hold at least 5% of the securitized loans through to completion, and further disallow firms to immediately book securitization profits. Instead, they would book the profits as the loans matured and would have that securitization income reduced if the loans performed badly due to weak underwriting standards.

While this is not quite as good as the 15-25% loan book hold-back I felt would be prudent, this is certainly a large step forward.

The 5% hold-back still amounts to 20 to 1 leverage in effect, atop the normal leverage that banks enjoy. Given banks particularly important place in our economy, I am not sure that is prudent enough.

While this is not quite as good as the minimum 15-25% hold-back, it is a large step forward from existing standards - yet I am still left wondering whether this is not a half measure.

I'm therefore hopeful that FASB rules will further help to dampen the capital leveraging effect through some proposed rules, yet to be issued.

Now, of course, reforming executive pay remains a important topic which needs serious attention in order to also reduce further systemic risk.

This is something I have written about previously, and that my internet "colleague", Rick Konrad, at Value Discipline, is writing about in greater detail.

I encourage you to visit his blog, read some of his posts (1, 2, 3) on the matter, and to add your voice by sending your elected official a quick email (find your congressperson here, find your senator here) encouraging such reform.

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