After digesting the latest salvo in the transparency wars, I find myself in the unusual and uncomfortable position of criticizing the FDIC. I do so with great regret. I am a fan of Ms. Bair as she has effectively navigated through the minefields of this continuing credit crisis.
One week ago, the FDIC waded knee-deep into the one of these minefields with the intention of striking "a middle ground" between "those who want to eliminate securitization completely and those who want little change." [Bloomberg, FDIC Seeks to Toughen Rules on Banks' Securitizations, December 15, 2009] Ms. Bair is further quoted as saying that she "look[s] forward to eventually finalizing strong, common-sense standards."
Common-sense isn't easy, especially where enormous profits are involved.
To some extent, Chairman Bair mischaracterizes the battle being waged over securitization. The battle is not between elimination of securitization and rules that merely codify the industry's self-serving Project Restart, which has failed to restart securitization. The real battle is between the sell-side industry and the buy-side investors, the latter remaining on strike and refusing to meaningfully restart the securitization market.
Regulators around the world have been moving heaven and earth, as well as spending trillions in taxpayer money, to address the problem of restarting securitization. However, as almost every policy maker has admitted, restarting securitization has proven exceedingly difficult and has required massive government intervention for the little that has occurred.
Obviously, there is a problem to restarting securitization that has evaded ASF, the Treasury, the Fed and the ECB. To Bair's credit, she has figured out that Paul Volcker was right in recommending last January that the systemic risk regulator meet with investors (the buy-side) to find out what they need to return to the marketplace for securitized products. Thus, she has said that FDIC will consider with particular focus the thoughts of the "buy-side community" in drafting the rules.
That would be a welcome change, a change that appears to have been led by the European Union and the European Central Bank. The EU passed their amendments to the Capital Requirements Directive last May, which included two major provisions: a 5% "skin-in-the-game" part and a "know-what-you-own" requirement that appears to apply to securitizations on a daily basis.
Indeed, the Governing Council of the European Central Bank (ECB) is now calling for public consultation on the issue of loan-level data in asset-backed securities. [Dec 17, 2009]. Restarting securitization is a primary goal of policy makers and regulators across the globe as its demise has been central to overly tight credit conditions. Ending securitization is not an option. Restarting it is becoming a main policy concern.
So, what battle should Bair have openly acknowledged?
The answer is very simple: Opacity vs. Transparency
As mentioned prominently by EU minister for internal markets and services, Charlie McCreevy, the banking industry has been lobbying forcefully to retain as many elements of opacity in securitization as possible while fighting strongly against the desire of the buy side to have more complete and timelier data with which to value and price securities. While that battle, which I call the Transparency Wars, has not been widely discussed in the U.S. press, it has been credibly reported in the European media.
Unfortunately, the FDIC has waded into this battle, stacking the deck against the buy side. The proposed rules regarding disclosure applicable to all securitizations contains the following language:
Prior to issuance of obligations and monthly while obligations are outstanding, information about the obligations and the securitized financial assets shall be disclosed to all potential investors at the financial asset, pool, and security-level sufficient to permit evaluation and analysis of the credit risk and performance of the obligations and financial assets. [italics and bold type added]
Essentially, the FDIC has adopted as its safe harbor the industry standard of monthly data for securitizations, even though that level of data disclosure has proven worthless to either prevent the credit crisis or to restart securitization.
What it boils down to, quite simply, is that Wall Street enjoys so much of an information advantage in structured finance that the buy side will no longer trade with it, fearing it will be handed large losses once again.
The buy side is on strike. It wants the information advantage enjoyed by Wall Street (who in many instances have access to much more timely data, a sizable asymmetrical information advantage as written in the Wall Street Journal, Heard on the Street, November 9, 2007) significantly reduced or completely eliminated through the release of daily, loan-level data, available to all.
By seeking comment on the monthly data provision instead of simply asking for comment on what level of data disclosure best meets the needs of investors and regulators, the FDIC has stacked the deck against those who believe that the best disinfectant is plenty of sunshine, every day (not like the weather in a sleepy Northwestern city, where sunshine is at at premium).
By stacking the deck in this manner, the FDIC has at a minimum, required the buy side to come groveling for daily data and to make a burdensome, affirmative case to change the monthly data format favored by the sell side.
This is the unintended consequence of adopting current practices as the starting point for rulemaking.
The question now becomes: How quickly can the buy-side organize and do they recognize that their desire for timelier, daily data is not only possible, but also the solution to the credit crisis.
Disclosure: No stocks mentioned