Wednesday, June 17, 2009

Financial Overhaul rules

Some highlights, but more later...
  • Residual Interests of 5% - pfandbriefe, covered bonds, etc. Consumer ABS deals typically had retained interests too - as an issuer, you can effectively value them at close to zero, pass the costs along to other investors (and ultimately the consumer/borrowers), and enjoy any upside with no risk. In CMBS the mechanism is to have the special servicer buy the first loss piece. For subprime HEQ, they just made horrible loans to people who never should have had them and sold them to investors who never should have bought them - that mechanism is currently working as well through foreclosures and invesment losses.
  • Lack of data on loans - Even in consumer and resi ABS, there are fairly sophisticated models built around fairly detailed data.
  • The SEC does not currently have a system to track ABS? Surely WAPO misinterpreted - I haven't finished the 85 page doc yet. Maybe their going to decimate the bid/ask and put Wall Street traders out of business, or at least severely hobble it, similar to what happened in corporates.
  • New rating scale for securitized products - this is a bad idea for so many reasons.
  • Indications that there is a problem with the issuer-paid ratings model - the flip side of that, a consumer-paid ratings model doesn't work either, because most consumers wouldn't pay for it (just the ones whose charters required it, and even they would busily re-write the rules). Investors need to focus their expenses on evaluating the investments - you get paid for doing your homework, not for taking the letter-rating off the guy next to you who did his homework.

  • Regarding the new rating scale, changing ratings on securitized products to some new scale, say S.AAA instead of AAA, doesn't do anything at all except add to confusion and opaqueness in the market place. Further, what does it mean for insurance companies that have ratios and charters based on the historical rating system - obviously they have to change their rules/policies. I'm a strong believer, along with the majority of the market I would imagine, that the ratings are more or less worthless. Yesterday's release makes note of this with the comment "Regulators should reduce their use of ratings in regulatory and supervisory practices where ever possible".
  • The lack of transparent information is an important issue - the more data, and the more normalized it is, the better it is for the market. However, I don't think the SEC has a clue what level of information is available in both the resi and CRE market - it's very comparable to the level of detail a bank would have if it were purchasing a portfolio of loans or another whole bank. The same can't be said for consumer ABS or CDOs.
None of this debate is new, and the government solutions have the same problems they did over a year ago. In fact, almost one year ago BOA published a report titled "The Illusion of Progress", which touched on all these topics (I'm more or less in agreement) and also discussed accounting changes and price transparency.

No comments: