Earlier this week, the SEC adopted significant changes to Regulation AB, which governs the offering process and disclosure and periodic reporting requirements for public offerings of asset-backed securities, including residential mortgage backed securities (RMBS). The revisions to Regulation AB were a long time coming—they were first proposed in 2010 and have drawn several rounds of comments from industry participants. Issuers must comply with the new rules no later than one year after publication in the Federal Registrar (or two years in the case of the asset-level disclosure requirements described below). The new rules do not address “risk retention” by sponsors which is the subject of a separate rule-making process.
Posts Tagged ‘Asset-backed securities’
Today [August 27, 2014] the Commission takes an important step to protect investors and promote capital formation, by enhancing the transparency of asset-backed securities (“ABS”) and by increasing the accountability of issuers of these securities. The securitization market is critical to our economy and can provide liquidity to nearly all the major economic sectors, including the automobile industry, the consumer credit industry, the leasing industry, and the commercial lending and credit markets.
Given the importance of this market, let’s also remember why we are here and the magnitude of the crisis in the ABS market. At the end of 2007, the ABS market consisted of more than $7 trillion of mortgage-backed securities and nearly $2.5 trillion of other outstanding ABS. However, by the fall of 2008, the securitization market had completely seized up. For example, in 2006 and 2007, new issuances of private-label residential mortgage-backed securities (“RMBS”) totaled $686 billion and $507 billion, respectively. In 2008, private-label RMBS issuance dropped to $9 billion, and flat-lined in 2009.
The Commission will today [August 27, 2014] consider recommendations of the staff for adopting two very important final rules in different, but closely related, areas—asset-backed securities and credit rating agencies.
The reforms before us today will add critical protections for investors and strengthen our securities markets by targeting products, activities and practices that were at the center of the financial crisis. With these measures, investors will have powerful new tools for independently evaluating the quality of asset-backed securities and credit ratings. And ABS issuers and rating agencies will be held accountable under significant new rules governing their activities. These reforms will make a real difference to investors and to our financial markets.
We will first consider the recommendation related to asset-backed securities, and then we will consider the rules relating to credit rating agencies.
A firm’s reputation is a valuable asset. Arguably, conventional wisdom suggests that a reputable firm will always act in the best interest of their clients to preserve the firm’s reputation. For example, in his testimony/defense of Goldman Sachs before Congress, the Chairman and CEO Lloyd Blankfein states, “We have been a client-centered firm for 140 years and if our clients believe that we don’t deserve their trust, we cannot survive.” In our forthcoming Review of Financial Studies article entitled Complex Securities and Underwriter Reputation: Do Reputable Underwriters Produce Better Securities?, we examine the extent to which this conventional wisdom holds with complex securities.
Rule 17g-5(c)(1) (the “Rule”) of the Securities Exchange Act of 1934 addresses nationally recognized statistical rating organization (“NRSRO”) conflict of interest concerns by prohibiting an NRSRO from issuing a credit rating where the person soliciting the rating was the source of 10% or more of the total net revenue of the NRSRO during the most recently ended fiscal year.  As noted by the Commission, this prohibition is necessary because such a person “will be in a position to exercise substantial influence on the NRSRO” and, as a result, “it will be difficult for the NRSRO to remain impartial, given the impact on the NRSRO’s income if the person withdrew its business.”  The Commission also recognized that the intent of the prohibition “is not to prohibit a business practice that is a normal part of an NRSRO’s activities,” and that the Commission may evaluate whether exemptive relief would be appropriate. 
In an important decision last week, a New York appellate court ruled that claims for breach of representations and warranties made in connection with residential mortgage-backed securities (RMBS) accrue when the representations and warranties are made, which typically occurs when the securitization closes. ACE Securities Corp. v. DB Structured Products, Inc., No.650980/12 (N.Y. App. Div. 1st Dep’t Dec. 19, 2013). The court held that the six-year contract statute of limitations begins to run at that time, instead of when a defendant refuses to comply with a plaintiff’s demand for a contractual remedy.
It has been more than six years since the onset of the credit crisis and we have documented for the first time in the past few months a significant increase in the number and size of settlements. Meanwhile, the pace of new filings has slowed as housing markets continue to improve and delinquencies and defaults decline. However, litigation arising from the credit crisis is far from over.
In this post, we discuss the recent trends of settlement activity and review some of the major settlements in credit crisis litigation. We also discuss mortgage settlements that are related to repurchase demands mainly between mortgage sellers and Fannie Mae and Freddie Mac. We then examine the current trends in filings, including the types of claims made, the nature of defendants and plaintiffs in the litigation, and the financial products involved.
Our main findings, which are discussed in greater detail below, include the following:
The Securities and Exchange Commission (“SEC” or “Commission”) today approved a joint rule reproposal to implement Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).  I am not able to support the release in the form approved because the reproposal does not contain necessary economic analyses and does not adequately consider alternatives to credit risk retention requirements or the interplay between those requirements and other regulatory reforms.
Before discussing these shortcomings, I want to recognize all the hard work the SEC’s staff in the Division of Corporation Finance and the Division of Economic and Risk Analysis (“DERA”) put into developing the joint rule reproposal. I also want to thank them for briefing me on the rulemaking and answering my questions.
While I am not able to vote in favor of the reproposal, I am encouraged that some improvements were made to the original proposal in response to public comments. For example, the reproposal removes the problematic premium capture cash reserve account approach. And, with respect to some classes of asset-backed securities (“ABS”), the reproposal revises various risk retention obligations and allows alternative incentive alignment practices.
On August 28, 2013, the FDIC, OCC, FRB, SEC, Federal Housing Finance Agency, and Department of Housing and Urban Development (collectively, the “Agencies”) issued a second Notice of Proposed Rulemaking (the “revised proposal”) that would implement the risk retention requirements of Section 941 of the Dodd-Frank Act, which amended the Securities Exchange Act of 1934 (the “Exchange Act”) by adding a new Section 15G. Section 15G requires the Agencies to issue rules that would generally require that a securitizer of asset-backed securities (“ABS”) retain an economic interest in not less than 5% of the credit risk of the assets collateralizing such ABS. As discussed in the April 19, 2011 Financial Services Alert, the first Notice of Proposed Rulemaking (the “original proposal”) was jointly approved in April 2011 by the Agencies. In response to numerous comments received on the original proposal, the Agencies collectively developed the revised proposal, which includes significant modifications.
In the recent NBER working paper, my co-author, Guillermo Ordoñez of the University of Pennsylvania, and I develop a model to examine the important role collateral plays in the economy. Where do safe assets come from? Empirical evidence suggests that the private sector creates more near riskless assets when the supply of government debt is low and reduces privately-created near riskless assets when the supply of government debt is high. Krishnamurthy and Vissing-Jorgensen (2012) show that the net supply of government debt is strongly negatively correlated with the net supply of private near-riskless debt.
The substitution between public and private safe debt is also shown by Krishnamurthy and Vissing-Jorgensen (2012) who document that changes in the supply of outstanding U.S. Treasuries have large effects on the yields of privately created assets. Gorton, Lewellen, and Metrick (2010) also find this relationship between government debt and privately produced substitutes. They document that the share of safe assets in the U.S. economy, including both U.S. Treasury debt and privately created near-riskless debt has remained constant as a percentage of all U.S. assets since 1952. Xie (2012) shows that the issuance of asset-backed securities tends to occur when the outstanding government debt is low and Sunderam (2012) documents the same phenomenon with respect to asset-backed commercial paper.
By “safe assets,” we mean government debt and privately created high quality debt, in particular, asset-backed securities. Such safe assets are used to collateralize repo, derivative positions, and are needed as collateral in clearing and settlement. See IMF (2012). Further, because they are ”information-insensitive” (in the nomenclature of Dang, Gorton, and Holmstrom (2012)), they are highly liquid and hence can store value without fear of capital losses in times of stress, a form of private money.