Friday, June 25, 2010

New consumer credit expansion to be stalled

As part of the new Financial Regulatory bill, investment banks that securitize consumer credit products will be required to hold at least 5% of any underwritten security on their balance sheets. Given the volume of credit card, auto, and mortgage loans that allows liquidity and diversification of this credit, firms that are required to hold 5% of each issue they originate could strain their capital levels in short order. For decades a bank's role has been distribution to allow continued financings to be underwritten and accepted by the broad market. Even with today's still diminished activity relative to the pre-crisis past this is a market of enormous flow and dollars.

On top of that banks that are required to hold these positions will not be allowed to hedge them. Under the new rules that would be viewed as "betting against" a security that a bank has sold to clients. There is no way out really. The choice will be to build a consumer credit balance sheet that requires significant amounts of capital over time or limit the business. That business would then presumably go to UBS, Credit Suisse, Deutsche, Nomura, and other firms that do not fall under the U.S. regulatory umbrella, if the business is done at all.

What should have been regulated is the quality of products that are allowed to be securitized, how the securities are rated, how the prospectuses can be plainly written, and what originators have a track record that qualifies them to have their product packaged and underwritten. Too much work no doubt so why not just hamstring the market as a whole(and scapegoat that banks once again) such that expansion of consumer credit in general becomes more expensive and more restricted.

Certainly we have been through a period in which very poor product, primarily mortgage, has severely damaged the reputation and track record of the consumer asset securitization markets. That does not mean that the concept of securitization and distribution itself is flawed. Done with decent well disclosed product, securitization of these assets is absolutely necessary to restore broader credit availability to small businesses, worthy households, and entry level individuals.

Why is this not obvious.


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