Financial Reform May Take 'Unintended' Effect on Securitization, Analysts Warn
The Dodd-Frank Act signed this morning by President Barack Obama could have a range of unintended consequences on the mortgage securitization market, according to various commentaries out today. In particular, the reform levels costly credit risk retention requirements at mortgage securitization issuers and exposes credit-rating agencies to greater liability. In the worst case scenario, market participants warn, the cost constraints and fear of litigation could stymie fragile signs of recovery seen in the securitization market so far. Standard & Poor's (S&P) president Deven Sharma already warned the legislation could expose rating agencies to greater liability for -- and lawsuits over -- ratings of mortgage-backed deals. "This could potentially lead to more suits as the change [to existing law] may permit claims of federal securities fraud to be brought against a credit rating agency that allegedly 'knowingly or recklessly failed to conduct . . . a reasonable investigation . . . or to obtain reasonable verification' of the data it relies on to determine credit ratings," Sharma said last week. The major credit-rating agencies -- Moody's Investors Service, Fitch Ratings and S&P -- "have instinctively pulled back from the new issue securitization market until they are better able to asses this new liability," wrote Barclays Capital analyst Joseph Astorina in commentary today. "We view this as an issue more for consumer [asset-backed securities] than for residential credit ABS, as issuance volumes in the latter have generally been lower and issuance that has come in that market has generally been [private-label]," he said. Talk among bond traders in the hours after ratification of the Dodd-Frank Act today raise the concern that it could in effect shut down new issuance in securitization altogether. The law's reforms concerning securitization are designed to remove the incentive of the "originate-to-distribute" model, according to a client alert today from law firm K&L Gates. "Residential lenders that do not wish to retain risk or do not have capital to do so may be left with an originate-to-distribute business consisting of plain vanilla mortgages," the firm said. "This ultimately may limit consumer choice, restrict the availability of consumer credit and stifle innovation in the residential mortgage market." Other "unintended" consequences cannot be known until the legislation is enforced, noted accounting firm Deloitte in commentary today. "By way of example, a driving element of the law has been to address the 'too big to fail' issue, reducing the risk that large firms might take excessive risk because they are in effect guaranteed to be bailed out in the event of a failure," the firm said. "But because this is an extremely complicated problem, no one actually knows what the consequences of the new law will be -- the new systemic regulator will probably make this a central issue as it sharpens its mandate in the coming months." One of the biggest criticisms of the sweeping financial regulation legislation that President Obama signed into law today does not specifically address the government-sponsored enterprises (GSEs). HousingWire sources inside the Congressional Republican delegation said during the process of debating the financial reform bill, leading Democrats in both houses of Congress "promised up and down the isle," that Congress will address the GSEs in the beginning of 2011, but Republicans say they will push for the debate to begin earlier. As HousingWire reported, Edward DeMarco, acting director of the Federal Housing Finance Agency, said there is no "silver bullet" for adequately winding down these firms. Write to Diana Golobay.