3:06 pm - Wednesday September 26, 2998

DFA and Skin in the game for securitization market

Asset backed securities are created by buying and bundling loans – such as residential mortgage loans, commercial loans or student loans – and creating securities backed by those assets, which are then sold to investors.

Often such a bundle of loans is divided into separate tranche of securities with varying levels of risks and returns.

Repayment on the loans are first shared with the holders of the lower-risk, lower-interest tranche first and then to the holders of higher-risk, higher-interest tranche categories.

Almost all the public offerings of asset backed securities in US are conducted through Securities Exchange Commission registration procedures known as shelf offerings.

Sometimes, ABS offerings are also issued as private placements which are of course exempt from such SEC registration.

Such private placements are bought by institutional investors.

During the recent financial crisis, ABS buyers suffered huge losses.

The crisis revealed that many investors were not fully aware of the risk in the underlying mortgages within the pool of securitized assets.

Not only this, certain intelligent issuers who knew more about the securitized assets, did not retain any portion of such ABS issues, thus escaping when the bad times struck.

Section 621 of Dodd Frank Act prohibits an underwriter, placement agent, initial purchaser, sponsor, or any affiliate or subsidiary of any such entity, of an asset-backed security from engaging in any transaction that would involve or result in any material conflict of interest with respect to any investor in a transaction arising out of such activity for a period of one year after the date of the first closing of the sale of the asset-backed security.

Section 941 requires the Commission, the Federal banking agencies, and, with respect residential mortgages, the Secretary of Housing and Urban Development and the Federal Housing Finance Agency to prescribe rules to require that a securitizer retain an economic interest in a material portion of the credit risk for any asset that it transfers, sells, or conveys to a third party.

The chairperson of the Financial Stability Oversight Council is tasked with coordinating this regulatory effort.

Many thanks SEC and FSOC for the inputs

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