Securitisation
June 16th, 2009 9:06 am | by John Jansen |The FT published a story this morning regarding an Obama Administration plan to overhaul the financial system which would force lenders to keep 5 percent of the credit risk of bundled securities. In this way securities firms would have “skin in the game” and would have less incentive to construct a pile of junk.
There are a couple of problems with that approach.
I may be wrong but I think that both Merrill and Citi had plenty of skin in the game. Each held the AAA pieces of some of the merdurinous stuff they constructed. Merrill has been folded into Bof A and Citi is a ward of the state. Each had a stake in the game but made very poor decisions by holding as much risk as they did.
How will the government enforce such a rule? It will create a massive new regulatory burden.
And will the rule forbid legitimate hedging and trading? If so how does one manage risk in that environment?
13 Responses to “Securitisation”
By Alex on Jun 16, 2009 | Reply
“Poor decisions” or egregious errors?
By John Jansen on Jun 16, 2009 | Reply
Egregious errors would be the better formulation.
By John Black on Jun 16, 2009 | Reply
Actually, enforcement should be pretty easy through the tax code.
Any gain where the securitizer did not retain at least 5% would be taxed at 65% without deductions.
Framework is already in place.
John
By John Jansen on Jun 16, 2009 | Reply
John,
Thank you,
John
By EMGuy on Jun 16, 2009 | Reply
Question 1: Isn’t the proposal akin to forming a covered bond market here ala Europe?
If so, question 1.5: Is it wise to emulate the Europeans when it comes to “markets”? Thanks.
By Alex Golubev on Jun 16, 2009 | Reply
“overcollateralization”, “residuals”. look them up, obama. This WILL help but only to the extent that 5% is greater than the expected loss on the whole securitization. So basically it will help a little with the nonexistent subprime market, but unnecessarily hurt the (nonexistent) prime securitizations. BTW, is he going to require the same of gov’t agencies or can we just keep skinning the taxpayers?
By Griff on Jun 16, 2009 | Reply
Paulson talked up covered bonds quite a bit last year, initially following the BSC “acquisition” by JPM. I don’t recall the exact mechanics, but want to say that credit card issuers (using a master trust for issuance) retain a small %% as at-risk; the lowest-rated credit card ABS publicly issued I think was BBB.
Merrill should’ve listened to their CDO trader in late 2006…the game was over.
By DFTT on Jun 16, 2009 | Reply
The suspicion on the street was that ML had lots of “skin in the game” whether they liked it or not because they couldn’t sell the lower or N/R tranches.
By Gary on Jun 16, 2009 | Reply
Obama’s great plan, presumably made with the advice of TurboTax Timmy and Subprime Contagion Well Contained Ben, is to require overcollateralization and/or residual tranches… which was already the case when all this credit stuff exploded
Whatever words we were supposed to read on Obama’s lips — the underlying message Obama was sending is very clear:
Obama and his team don’t understand the problem and are not up to the task of fixing the system.
By joe on Jun 16, 2009 | Reply
Citi et al did not (at least initially) hold the Aaa’s on balance sheet they held them in SIV. So, the SIV would by Aaa RMBS for $100, Citi in turn would provide a 364-day liquidity line to the SIV. The SIV would hold Aaa paper and liquidity backed by a Prime-1 Bank so it could issue CP. Since the liquidity line was a 364-day facility, Citi didn’t need to hold capital against the liquidity line. So its return on equity was infinite and it collected say 20-25 bp in fees to provide the liquidity line and other sundry services to the SIV. When the CP market for asset backed paper dried up, these liquidity lines were drawn and then these Aaa came back on balance sheet and then you needed capital. In short they had skin in the game but structured in a way that the regulators and investors said they didn’t. If you had required more capital to back these liquidity lines to SIV, I think it would have led to these structures being more expensive as it would have required them to raise additional capital to support these and in turn it woudl have limited demand.
By Bman on Jun 16, 2009 | Reply
The shell game continues – “toxic, “distressed”, “legacy assets” – whatever you want to call them, are still out there and I do not see a 25% rise in home values happening anytime soon. Still waiting to hear what Plan B is……
By Gary on Jun 16, 2009 | Reply
joe — Citi (and many others) held lots of residual tranches on their books. This was in addition to the allegedly “AAA” tranches they shoved into the SIVs. Also, to get stamped “AAA”, most of these deals were (supposedly) overcollateralized — meaning the underlying trust (that pays all the tranches) held more collateral than the sum of all the tranches. First loss was supposed to be absorbed by that overcollateralization, leaving the securitized tranches with a “AAA” rating (losses “could *never* be greater” than the overcollateralization)
The securitizers already had “skin in the game” — which is why so many have failed and so many others are on Fed/Treasury life support.
The fact that Obama and team don’t understand that, not even with 20/20 hindsight, is just plain scary
By know_nothing on Jun 16, 2009 | Reply
How about this: the entire bonus pool for whomever structures this stuff will be comprised of the cash flow from the residuals.