FDIC Approves Proposal of Safe Harbor for Securitizations

The FDIC's board ""approved a formal proposal"":http://www.fdic.gov/news/news/press/2010/pr10112.html Tuesday that would impose stricter rules on banks that package loans as mortgage-backed securities (MBS).

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In order for the bundled mortgages to be protected from seizure under the FDIC's safe harbor arrangement in the event the federal agency steps in to shut down the institution, lenders would be required to retain at least 5 percent of the securities on their own books. However, loans sold to Fannie Mae, Freddie Mac, or Ginnie Mae would be exempt.

FDIC Chairman Bair commented, ""The market is clearly trying to find a new securitization model, with investors placing a premium on transparency throughout the process. With the system awash in cash, investor appetite is coming back. Now is the time to act to put prudent controls in place before the significant issues we saw during the crisis return.""

Bair added, ""We must acknowledge the role that the ‘originate to distribute’ model played during the crisis. Insured institutions and our economy have lost many billions because our mortgage finance system broke down.""

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According to Bair, the rule aims to correct the weaknesses in securitization, but critics are saying it creates an uneven playing field since it applies only to banks and not other financial firms who participate in the secondary market.

Comptroller of the Currency John C. Dugan, one of two dissenting votes on the agency’s board, said, “My concern has always been that, in attempting to address these and other securitization issues to revive the securitization market, [the new rule would] make the problem worse by needlessly deterring the use of securitizations in the first instance -- because securitization remains a critically important vehicle to provide liquidity in mortgage markets.”

Dugan also noted that Congress is already considering legislation that includes a 5 percent risk retention clause for securitizations that would apply to all securitizers â€" not just bank securitizers. He also faulted the FDIC’s proposed rule for not attempting to improve underwriting standards for mortgages by establishing minimum standards by regulation.

Richard Dorfman, managing director and head of the Securities Industry and Financial Markets Association (SIFMA) Securitization Group, says the proposed rule could potentially hamper a recovery in the securitization markets.

“Issuers, investors and credit rating agencies require certainty at the time of issuance, secondary trading, and in financing transactions as to the treatment of bank securitizations in the event of insolvency,” Dorfman said. “Some of the FDIC’s proposed rules may not provide that certainty and therefore could be detrimental to the re-establishment of well-functioning securitization markets.”