A Good idea

The House has released its proposal for financial regulatory reform. While some of it is dicey, including the Resolution Fund (it charges fees to the surviving firms to pay for the failed firm) and also the wind down provision specifically excludes secured bond holders. All in all it is rather vague, which given the history means the regulators will have the tools but not the will to enforce the law.

This particular section though, was pretty spot on in regards to securitization.
Credit Risk Retention

• Directs the federal banking regulators and the Securities and Exchange Commission to jointly write rules to require creditors to retain 10 percent or more, of the credit risk associated with any loans that are transferred or sold including for the purpose of securitization. Regulators can adjust the level of risk retention above or below 10 percent, but not lower than 5 percent. In the case of the securitization of assets that are not originated by creditors, the regulators will require the securitizer to retain the credit risk.

I have thought all along that the originate-to-distribute model was flawed because it favored applying teaser rates to allow the borrower to make the minimum amount of payments necessary to then sell their loan asset into the securitized pool. It will be interesting to see, again the wording is vague, how this portion gets hammered out. It's one thing if the pools, is just that a pool which pays out regular cash flows. However, if the pool is tranched so that i-bank can create super senior tranches all the way down to the equity tranche, then what portion will the originator have to keep. Would it be just the equity portion which suffers first loss or will it be a portion of each tranche? (If you have no idea what I am talking about with tranching please click here for a primer.)

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