Treasury plans strict rules for securitisation

By Krishna Guha and Tom Braithwaite in Washington and Francesco Guerrera and Aline van Duyn in New York The US Treasury is planning a sweeping overhaul of securitisation markets with tough new rules designed to restore confidence by reducing the incentive for lenders to originate bad loans and flip them on to investors. The authorities plan to force lenders to retain part of the credit risk of the loans that are bundled into securities and to end the gain-on-sale accounting rules that helped spur the boom of the markets at the heart of the financial crisis. The aim is to revitalise the markets for securities backed by mortgages and other assets without re-creating the systemic risks that turned boom to bust in 2007. The plan is part of a wider overhaul of regulation to be unveiled on Tuesday. A Treasury spokesman said that while securitisation had made credit more widely available, breaking the direct link between borrower and lender had “led to a general erosion of lending standards, resulting in a serious market failure that fed the housing boom and deepened the housing bust”. Securitised markets – which financed more than half of all credit in the US in the years immediately preceeding the crisis – are essential for the US economy. Without a recovery in these markets, the flow of credit will not return to more normal levels, even if US banks overcome their problems. The Treasury hopes its plan will help bring these markets back to a more stable form by improving information and changing incentives. However, bankers warned that the new rules would reduce incentives to package assets into securities, raising financing costs. “It is the beginning of the unwinding of the securitisation-for-sale model,” a senior Wall Street banker said. “By forcing lenders to keep part of the loans and scrapping ‘gain-for-sale’, the government will raise the cost of capital and put a damper on the reopening of credit markets.” Some experts also question the wisdom of forcing banks to retain exposure to loans sold as securities, saying that it might be better to encourage banks to properly rid themselves of all exposure to such credits. The Treasury plans to force lenders to retain at least 5 per cent of the credit risk of loans that are securitised, ensuring that they have what investors call “skin in the game”. The 5 per cent rule – which looks set to be applied in Europe as well – is less draconian than some bankers feared. The proposed elimination of “gain on sale accounting” is to prevent financial companies from booking paper profits on loans – packaged into securities – as soon as they were sold to investors. Banks would only be able to record income from securitisation over time as payments are received. Brokers’ fees and commissions would also be disbursed over time rather than up front, and would be reduced if an asset performed badly due to bad underwriting. The US authorities also plan to stop credit rating agencies from assigning the same types of ratings to structured credit products that are assigned to corporate and sovereign bonds, meaning there would be no more AAA-rated subprime securities. Contracts would be standardised to ease comparability and trades included in an electronic database currently used for corporate bonds. Sponsors would be required to stand behind their securities by providing warranties as to the origination and the underwriting standards on the loans. Credit ratings agencies – most of which are paid by the issuers to rate securities – would have to strengthen their policies for handling conflicts of interest. They would have to develop a new vocabulary to rate structured credit – a move intended to underscore the fact that a triple A rating on a corporate bond and on a mortgage-backed security mean very different things.