Last week's proposal by the Federal Deposit Insurance Corp. to put a rule into law that would protect favorable accounting treatment for loans that have been pooled and securitized is being greeting by open arms in the asset-backed and mortgage-backed worlds.
The measure has the potential of bringing clarity and stability to the issue of property rights as it relates to the future of securitization.
When banks securitize assets so that they can sell them for immediate profit, they are able to remove the loans from their balance sheets. Under a Financial Accounting Standards Board accounting guideline passed half a year ago, called Financial Accounting Statement 125, banks receive that benefit only if the securitized loans cannot be pulled out of the pool, even in cases of bankruptcy.
The FDIC, however, in its role as receiver of failed banks, has the right to reclaim assets that were transferred in a securitization by a company or entity that was insured by them.
Although the FDIC made a public statement last December that it would not exercise that right, banks, legislators and lawyers for FASB and its subcommittees did not trust that this would be the case, and conducted a campaign to formalize the FDIC's stated policy.
The FDIC is now finally responding, seeking to limit its own power to take loans out of securitization pools.
"Only a rule, which is binding, would provide sufficient certainty regarding the FDIC's treatment of securitizations and participations," the FDIC said in a summary of the comment letters it received.
For market players, this news is heartening in that it will secure once and for all that assets pooled for securitization cannot be removed by an outside source. According to insiders, if a bank was suddenly told that pooled assets may be put back on their balance sheets because the FDIC reclaimed them, the bank would incur a tremendous liability that would surely wreak havoc on the whole system.
"You cannot have an economic system without property rights," said Peter Rubinstein, head of asset-backed research at Prudential Securities Inc. "And so, you've got to establish that when a loan is sold into a trust, it is sold with no recourse it really belongs to the trust. And if you don't have that basic property right, then what do you have?"
According to Andy Wasko, a spokesman for the Bond Market Association, his organization was supportive of the original FDIC policy statement on the subject matter, and is very happy that the FDIC took this additional action.
"We're hopeful this action will be sufficient to bring comfort to market participants and other commentators and that this area can now benefit from additional legal certainty and basically quiet down the uncertainty that exists," Wasko said.
"From our perspective, it is a powerful statement about the role that securitization can play in the financial markets and the economy," he added. "The fact that the FDIC appears to be recognizing that and doing what it can to help is a very good thing, as we see it."