In June, FASB changed the ground rules for securitization accounting when it adopted FAS 166 and 167. The “Q” (qualifying special purpose entity) is eliminated and, along with it, automatic off-balance sheet treatment for transfers of financial assets into securitization entities. Instead, securitizations must be evaluated for consolidation by internet holders with both:

a) The power to direct activities that most significantly impact the securitization’s economic performance, and
b) The obligation to absorb losses/receive benefits that could potentially be significant.

(For more on FAS 166 and 167, see the August HousingWire Magazine – it’s not too late to subscribe – for a full length discussion of these new rules and the political currents swirling around them.)

It’s been about 18 months since FASB knuckled down to the project of resolving the Q and for about 12 of those months, no one complained much about how much time was passing. Securitization markets were, at best, comatose. Moreover, FASB had put in place extensive disclosure requirements for sponsors of existing deals effective this year.

Now, however, vanilla securitization markets are reviving – largely in response to the Fed’s TALF program. And there are even signs mortgage securitization is returning as well. This week, raters DBRS announced that in the past few weeks they have received 12 requests to rate new residential mortgage deals from private issuers. Collateral is equally split between prime and subprime, seasoning ranges from 1 month to eight years. These securitizations are the first, after eights months of drought in the RMBS market (not counting re-REMIC activity).

It’s not too soon, then, to starting asking how the new rules may shape RMBS markets going forward. Here are some thoughts.

First, it seems likely the new accounting regime acts as a drag on non-agency mortgage securitization – certainly as compared to the old bubble-icious days. A major incentive, getting the loans off the balance sheet, is effectively removed. Regulators haven’t yet determined the impact on regulatory risk capital requirements (see my upcoming 'Kitchen Sink' in the August issue of HW Magazine for more on the likelihood they will), but in any case, the capital markets can be expected to adjust institutions’ share and debt prices to reflect the impact on capital ratios of "on-boarding" (to use the Federal Reserve’s term for it) securitized loans.

To the extent that institutions are forced to hold more capital, the cost of funding loan operations in securities markets should rise (once upon a time, a lowest cost of funding argued for securitizing financial assets). Lenders can be expected to pass the higher, capital adjusted cost of funding mortgage loans, on to borrowers.

In this context, the administration’s proposal to require financial institutions issuing asset and mortgage-backed securities to hold 5% unhedged participations (road-rashed skin in the game) seems even less plausible. (The concept has more holes than Swiss cheese – why ask any business not to offset anticipated risks? And how to measure that 5%? Face or market value? What is the economic justification for 5%? Why not 1%, etc.) Would it not be more straightforward, in the brave new world of a re-regulated financial system, to make sure banks hold risk capital against securitized loans?

The new securitization accounting regime also raises questions about the future of Fannie and Freddie – or should I say, the future of the banking industry’s stance on Fannie and Freddie. Historically, the banking lobby has given the anti-GSE movement much of its momentum. Used to be Fannie and Freddie were the sole subjects of anti-systemic risk campaigns. At less lofty policy levels, banks objected to the GSEs’ funding advantage in the implicit government guarantee on their debt(while neglecting to admit how cheap FDIC deposits are), the lock the GSEs had mortgage market share with their highly standardized, deeply liquid MBS programs (well, the banking sector sure gave the GSEs a run for their money with those high yielding subprime concealed weapons, didn’t they?)

All that’s changed, of course, along with the “policy” climate. You can still find some die-hards carrying their “The End Is Coming Blame Fannie & Freddie” placards around the web, but many in that crusade have pinned their Defenders of Pure Capitalism buttons to the inside of their jackets and are now singing populist laments about the banks; the billions of tax dollars they’ve inhaled and not yet made a loan, their cowardly “too big to fail” protections and their tower-of-Babel systemic risk.

Full-tilt policy schizophrenia reigns.

You’ll find elected representatives coming out of one hearing where they excoriate bank execs for not lending, and going into another where they tenderly commiserate with the bank exec apparently threatened by another branch of government for trying to ensure taxpayers got value and not systemic mayhem for their investment.

In this environment, banks may want room to waffle too. They may find what they want most is some form of housing GSE that underpins primary and secondary mortgage markets just like Fannie and Freddie of yore. Under the new accounting rules, the best mortgage banking play may be to make conforming loans (as big as Congress will allow them to be), SELL them into GSE MBS (taking gains on sale and booking servicing assets, and push the cost of capital onto the GSEs’ plate. (Recall, the straw that broke the GSEs was the market’s discovery, a year ago, that killing the Q and changing consolidation rules would mean the GSEs put all those loans behind their securities on their own balance sheets.))

The crisis has also underlined the importance of those hungry big GSE portfolios. In the old days, Fannie and Freddie maintained a ceiling on MBS yields (translates to a ceiling on mortgage interest rates) through opportunistic investment in their own securities. Their presence made the market stable for the other participants, like U.S. commercial banks and foreign central banks looking for a place to put their bulging U.S. dollar reserves.

When mortgage spreads were in virtual free fall last autumn, the Fed stepped in with its MBS purchase program (allowing spreads to tighten to historically narrow levels). But the Fed is scheduled to stop the purchases at the end of this year. The GSEs aren’t going to step back in either – starting in 2010 they are required by law to reduce their portfolios 10% per annum. The mortgage market has begun to worry about this possibility – and the possibility that MBS prices could plummet five, ten points – who knows, it’s never happened like this ever before – on the Fed’s departure.

U.S. banks – as the single largest private institutional investors sector after the GSEs – have the most to loose. Or should we say, if the Fed leaves, the banks have the most tangible capital to loose (their MBS are largely carried as available for sale, with changes in fair value reflected in shareholders equity). And the Fed cannot stay forever. The bank lobby may well find itself in the position of begging Congress to reinstate the old market mechanism that was Fannie and Freddie.

Read more on the Q in the August issue of HousingWire Magazine.

Editor’s note: Linda Lowell is a 20-year-plus veteran of MBS and ABS research at a handful of Wall Street firms. She is currently principal of OffStreet Research LLC, and is a columnist for Market News International and HousingWire Magazine.