The Department of the Treasurys announcement on the new securitization regulation shouldnt come as a surprise. Although most ABS players believe the market will return to some level of normalcy, it's widely understood that the game would be played according to new standards.
The core of the new regulation revolves around the 5% retention rule that forces financial institutions to increase their capital cushions to absorb losses when times are tough as well as to make themselves more liquid. This would also allow these institutions to quickly move in and out of various holdings "with more stringent requirements for the largest and most interconnected firms," said sources.
But since times are already tough, it is likely that the financial institution might have to bite off a bigger piece. One source said that banks might be looking at a rate closer to 8% initially and only over the longer term will the 5% be enacted.
It becomes clear that the new regulation threatens to change the price of capital, not just for originators but for consumers as well. Consumers might have to suffer more punitive costs for products that they buy.
But the devil remains in the details.
Europe has already implemented the 5% retention requirement. Market sources said it is likely that Australia will soon adopt a similar requirement.
However, the sources said that the implementation of these regulations would work if implementation efforts were coordinated between countries even if the political wrangling driving the regulatory machine might create nuances across the board.
The goal should be to avoid mismatched standards globally, said one market source. We need consistent standards across industries and that requires global coordination between regulators and coordination of what is mandated or not this needs to be consistent across jurisdictions.
The good news is that the regulations at this initial stage look less punitive than was initially expected. This serves as a public acknowledgement that the regulators still believe in the existence of a securitization market and that, instead of finger pointing, are taking the first steps toward setting up a less risky and more certain future for the industry.
In an op-ed piece that ran in the Washington Post this week, Treasury Secretary Timothy Geithner and Director of the National Economic Council Lawrence Summers outlined the case for financial regulatory reform and offered a brief preview of the proposals the administration announced today.
Geithner and Summers wrote that the framework for financial regulation suffers from an outdated conception of financial risk. In recent years, the pace of innovation in the financial sector has outstripped the pace of regulatory modernization, leaving entire markets and market participants largely unregulated, they said.
Ironically these updated regulations are likely to return the market to its more adolescent state, where structures were sound and simple and where investors understood the assets behind the structure.