Comptroller Warns of Over-Regulating Secondary Market

A key Treasury official and regulator of the nation's largest banks is publicly speaking out against new rules that would require lenders to retain some of the risk on[IMAGE]mortgages and other assets sold to investors â€" proposed reforms that would ensure they keep more ""skin in the game,"" so to speak.

""In remarks at the American Securitization Forum's"":http://www.occ.gov/ftp/release/2010-13.htm (ASF) annual convention in Maryland this week, Comptroller of the Currency John C. Dugan urged policymakers to instead focus reform efforts on strengthening loan underwriting standards. He said improving loan quality would play a much larger role in reforming secondary markets than risk retention proposals that could hamper an already-tenuous securitization industry and further diminish credit availability.

""Done correctly, securitization helps consumers and businesses by increasing the availability of credit on terms that might otherwise be unavailable,"" Dugan said.

The secondary market for residential mortgage-backed securities (RMBS) has essentially screeched to a complete halt since the subprime crisis set in, and the trading of commercial mortgage-backed securities (CMBS) just broke its gridlock last November when Developers Diversified Realty and Goldman Sachs completed the first new-issue offering in more than a year.

The stalled secondary market has been one of the reasons banks have held on to credit so tightly. For years, banks have been able to sell bundled mortgages in the secondary market as a means of freeing up liquidity for more lending, but along with passing the debt, accounting rules and regulations also allowed them to pass off the risk associated with those loans to investors.

Dugan stressed to ASF attendees ""just how important securitization is to our economy,"" but also acknowledged that the process ""played a significant role in the crisis, and nobody should think that we can just wait for the market to stabilize and then go back to business as before.""

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Also speaking at the ASF convention, Michael Barr, assistant Treasury secretary for financial institutions, echoed Dugan's sentiments that ""We cannot build securitization on old infrastructure."" Barr said the packaging and selling of asset pools ""must be governed by rules,"" and provide transparency.

Along this line of new rules, federal regulators have adopted new accounting guidelines that require banks to bring securitized mortgages back onto their balance sheets to better align risk and related capital reserves.

On top of the new mathwork, the House has proposed requiring banks and other loan securitizers to retain at least 5 percent of the risk associated with the debt they package into securities and sell to investors. The Senate has proposed a higher risk retention of 10 percent. Such a statute is intended to ensure lenders have a greater interest in ensuring the loans are sound and borrowers have the ability to repay.

The lack of such ""skin in the game"" has become clearly evident with skyrocketing delinquency rates of both RMBS and CMBS loans issued at the height of the real estate boom.

But Dugan says the double jeopardy accounting rules and proposed risk retention requirements create a potential problem.

""Where a securitizer retains a material risk of loss on loans transferred in a securitization, the new accounting and regulatory capital rules may require that all loans in the securitization vehicle be kept on the bank's balance sheet - not just the amount of risk required to be retained,"" Dugan said. ""This could significantly increase the regulatory capital charge for such securitizations.""

The comptroller said a better and more direct way to assure sound underwriting for all mortgages, regardless of whether they are sold or held, would be to set minimum standards by regulation and stipulate that if the standards were met, there would be no need for skin-in-the-game risk retention requirements.

""We could do this,"" he said. ""Bank and thrift regulators could establish minimum underwriting standards for all mortgages originated, purchased, or sold by banks, thrifts, and - very importantly - by all of their affiliates. The Federal Housing Finance Agency could ensure similar treatment for all mortgages purchased or accepted as collateral by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. And the Federal Housing Administration, which already establishes minimum underwriting standards for U.S. government-guaranteed mortgages, could coordinate those actions with the other regulators.""