Tuesday, March 16, 2010

Who Is Assaulting the FDIC?

Original posted on the Housing Wire by Linda Lowell:

No one was surprised last week (March 11) when the board of the Federal Deposit Insurance Corporation (FDIC) extended the “transitional safe harbor” for securitizations, first adopted last November. That’s because Michael Krimminger, the FDIC Chairman’s Special Advisor for Policy, signaled the extension in February during a panel discussion at the annual American Securitization Forum (ASF) meeting.

What should have generated comment was the fact the board pushed the deadline back by a full six months, from March 31, 2010 to Sept. 30, 2010. The FDIC is in the midst of a rulemaking process that would replace the transitional safe harbor with a permanent safe harbor, but one conditioned on compliance with “tough” new securitization standards covering transaction structures, disclosures, compensation of underwriters, raters and other interested third parties, and skin-in-the-game levels. The transitional safe harbor’s sunset date is tied, for now, to the progress of that rulemaking process.

In covering the extension, the media and blogscape had apparently forgotten regulators split on the rule when FDIC staff unveiled it last year. Or maybe they hadn’t read Chris Whalen’s March 9 opinion piece in the American Banker on the “temerity” of banks to oppose the rule. Even if you didn’t agree with him, you might have wondered if ”the critics of the FDIC initiative who work at the Fed, OCC, SIFMA, the American Securitization Forum” were winning.

Some Background
I’d like to construct a narrative, peek behind the curtain of press releases for a glimpse of the struggle for the soul of American securities markets. But first, as a courtesy to readers who don’t want to click a bunch of links, let me briefly explain the pretext for the FDIC’s crusade, the securitization safe harbor.

The safe harbor provisions in question assure investors and raters that the FDIC will not use its statutory authority to reclaim the underlying assets transferred to a qualifying securitization by an insured institution that subsequently fails. (The standard legal and structural procedures that make a transaction bankruptcy “remote” do not work if the sponsor is a bank, as bankruptcy law does not apply to FDIC-insured institutions.)

The safe harbor provisions in place since 2000 required that transactions qualify for sale treatment under generally accepted accounting principles. Implementation this year of FAS 166/167 puts sale treatment in question for many asset-backed securitizations, forcing the FDIC to revise its safe harbor conditions or trigger wholesale downgrades of formerly triple-A securities and halt current securitization by banks of, for instance, credit cards, student and auto loans and commercial obligations. The solution adopted in November 2009 was to permanently grandfather securitizations and participations in process as of March 31, 2010 under the 2000 rule.

Chain of Events
As I said, the original deadline was set last November. Before that vote, FDIC chairman Sheila Bair and staff indicated they already had in hand a new set of conditions under which securitizations after March 31 would be eligible for the safe harbor. If not once, then twice, Bair referred to them as “a good set of conditions.”

The only steps remaining were to seek “feedback” from other regulators on that good set and “work to incorporate their insights” (as Bair put it during the meeting) into a Notice of Public Rulemaking (NPR). That NPR would be presented to the board for its vote at its meeting in December.

In other words, last November, Bair and her staff assumed about four months was plenty of time to conduct “interdepartmental consultations,” tweak the reforms to please the other regulators, publish the NPR for Public comment, digest the comments, and formally adopt them. Plenty of time as well for the industry “to transition” to a revolutionized securitization framework.

As we see now, it didn’t work that way. Since I had read Whalen’s op ed piece, I did wonder if the OCC and Fed were being uncollegial, or even hostile. So I went back to search the public record for clues. Among other things, I watched archived video of the public portions of the November and December 2010 FDIC board meetings. The proceedings are dry and straightforward in the extreme, and most of what passes for discussion is actually staff and board members reading their statements into the record. If there is disagreement, it is not apparent from the demeanor of the participants.

However, even without the benefit of hindsight, it should be apparent that John Dugan, board member and Chairman of the Office of the Comptroller of the Currency (OCC) fired a shot across Bair’s bow at the November meeting when he called for a “robust interagency process.”

November Devolves into December
As that interagency process is not public, we can only imagine its tone and substantive events from the apparent outcome: by the Dec. 15, 2009, meeting the proffered NPR had devolved into an Advanced Notice of Proposed Rulemaking (ANPR). I don’t follow FDIC processes close enough to be sure, but I gather an NPR is like saying to the insured depository institutions (IDI) ‘This is how it’s going down, so deal with it,” while an ANPR is more like, “This is what we’d like to do, but the details, for all kinds of reasons, may not yet be engraved in stone.”

Moreover, Bair and staff had been forced to re-label that “good set of conditions” a “sample regulatory text that is going to be attached to the advanced notice of proposed rulemaking.” They are now an appendix. The point of the ANPR would be “seek comment from the public on a wide variety of questions that will focus in on specific issues that have come up in the securitization process.” The ANPR approved by the board December 15 and published in the Federal Register Jan. 7, 2010, calls it “preliminary,” a “draft” and “one example.”

The ANPR specifically states, “The Board’s approval of the ANPR should not be considered as signifying adoption or recommendation of the preliminary regulatory text, but the text does provide context for response to the questions.”

Dugan Leads the Counteroffensive
After the ANPR had been presented for a vote, Bair turned first to Dugan, who stated his support of the rulemaking’s goals, but also said, “After hearing concerns expressed by other agencies and other interested parties, I was not comfortable moving forward with a specific notice of proposed rulemaking.”

According to Dugan, taking the ANPR approach instead “will stimulate robust comment on this issue now, but in a way that will minimize unintended consequences.” The ANPR might “crystallize issues for comment …. but I want to be clear that these are only examples, do not indicate the presumptive view of the Board, and in fact, include a number of provisions with which I would have concerns.”

He listed a number of concerns, including the minimum retention requirement (aka, skin-in-the-game), limiting transactions to six credit tranches, barring all external credit support, subjecting private placements to the same disclosure rules as public deals, and the 12-month seasoning requirement for securitized loans. He contributed to the record the fact that other agencies, such as the Federal Reserve and the Securities and Exchange Commission, have “a keen interest in this rule and specific expertise to contribute.” He pointed out that many of the same issues treated in the ANPR are addressed by the financial reform legislation working its way through Congress and should be taken into account to avoid unnecessary overlap or conflicting requirements. Finally, because the rulemaking was confined to IDIs, it risked “driving the market to foreign banks and less regulated financial institutions.”

Dugan wasn’t the only FDIC director with reservations either. Acting Director of the Office of Thrift Supervision, John Bowman, also wanted “robust” comment and continued participation of other regulators in the process, citing the SEC, the Fed, and Treasury by name. He cautioned against creating regulatory gaps and differential treatment of different segments of the financial industry. And he echoed Dugan’s concerns about the sample text, adding “it should not serve to narrow the focus of commenters.”

The Split
In case you’re wondering, there are five directors on the FDIC board: Directors Dugan and Bowman, as well as the Chairman, Vice Chairman Martin Gruenberg and Director Thomas Curry. From his statement, I gather Gruenberg stands with Bair. The sample regulatory language appended to the ANPR was developed by staff “in a careful and thoughtful way” and he would like to hear comment it. Being sensitive to treating banks differently from non-insured institutions is good, but he would be more concerned to find the FDIC had not moved ahead “for fear of what-nonbank institutions may or may not be permitted to do.”

Curry was brief and ambiguous: recent interagency discussion have identified most of the issues with this approach, public comment will allow affected parties to comment and any final regulation will result from the staff’s thorough assessment of all the comments and insights provided.

I conclude that, as of the December meeting, the split was maybe 2 for, 3 against, but probably 2 to 2 with Curry on the fence.

Dugan Takes It Public
In case no one watched the December 15 board meeting, Dugan also released a longer version of his comments in a statement.

He didn’t drop the subject either, following up with a speech in February at the ASF meeting in which he critiqued “skin-in-the-game proposals”. In particular, if the stated goal of the FDIC proposal is to prevent the loose underwriting fostered by the “originate-to-distribute model” of securitization, why not attack the problem directly? Why not establish minimum underwriting standards for residential mortgages? Minimum retention requirements are indirect, cannot be guaranteed to work and raise a number of significant accounting and regulatory capital issues. (I like Dugan’s explanation – it’s simple and clear – but I also worked through them in “Taken Together, Risk Retention and Fas 167 Could Stop the Revival of Securitization”).

Is the FDIC Fighting Back?
Bair is known for her independence and ability to press in public forums for her solutions to problems in the current crisis. Last year, after “interdepartmental consultation” had to be in full swing (at the December board meeting, Krimminger said the first interagency meeting was November 20), Bair pushed her securitization agenda in a December 4 Bloomberg interview that received wide notice under the headline “Asset-Backed Bond Market Must Accept Tougher Rules, Bair Says.”

The FDIC chairman told Dawn Kopecki:

• ABS market would not be weaned from government assistance until banks embrace stiffer guidelines (an apparent reference to TALF);
• Nobody has any confidence in the securities;
• To foster confidence the rule was going to be “heavy” on disclosure, underwriting quality, incentives, skin-in-the-game requirements;
• The rules would be out for 45 days of public comment and would take effect as early as March 31.

Krimminger, Bair’s special advisor for policy, was sounding just as confident the rules would be implemented for securitizations and participations in process after March 31 when he spoke with Whalen for his blog, the Institutional Risk Analyst (IRA) (December 14, 2009. It also ran in the January 2010 HousingWire Magazine.)

Krimminger had another chance to promote his “good set of conditions” at the ASF meeting in February. Unfortunately the text of his comments is not available from the FDIC (I asked) and so far as I can “Google”, the press gave scant coverage to anything but his saying an extension was likely. Structured Finance News did note his explanation that skin-in-the-game requirements were driven by the extraordinary losses in the subprime market.

The most likely speaking opportunity, for Bair to mention “our proposed conditions for regulatory safe harbor” was the Commercial Mortgage Securities Association’s (CMSA) annual conference in January. Check it out, but I think the closest she came to firing back at Dugan, et al, was here:

We are working with other regulators to achieve consistent regulatory reforms that will help prevent the arbitrage between different types of lenders and different types of securitizers. That said, I believe it is appropriate to set high qualitative standards for insured institutions, given their federal backing through insured deposits.

Interdepartmental Consultation or Warfare?
FDIC officials may be subdued in promoting their “good set of conditions”, but they have a champion. Bank industry risk guru Whalen has ridden into the lists on their behalf. His viewpoint column in the American Banker, “Stop Blocking FDIC Securitization Effort” (March 9, 2010) casts an entirely different light on the interdepartmental consultation.

According to Whalen, “many regulatory agencies such as the Federal Reserve Board and the OCC, financial institutions and their trade associations are fighting the FDIC effort.” He didn’t call out the financial institutions by name, but he does name trade associations, ASF and the Securities Industry and Financial Markets Association (SIFMA).

I was shocked and confused when I read this last week. Whalen seemed to be alluding to something rougher going on behind the scenes than Dugan’s or Bowman’s reasonable comments would suggest.

Happily, Whalen elaborates in this week’s IRA. It’s a conspiracy, led as usual by corporate interests:

“We hear that the President’s Working Group (PWG) on Financial Services is preparing a “white paper,” in cooperation with the Federal Reserve Board and the Office of the Comptroller, to block the FDIC reform effort. This campaign, which apparently was orchestrated by the largest dealer banks, is intended to derail the new rules proposed by the FDIC mandating greater transparency and disclosure for bank sponsored residential mortgage securitization deals.”

Gosh, what’s a white paper going to do? Put the FDIC to sleep? That’ll stop ‘em from making those pesky rules!

Who remembers the PWG’s March 2008 Policy statement on the financial market crisis? If memory serves, it contained more than a few recommendations that sounded pretty substantive and potentially annoying to big finance at the time. One recommendation that I know bore fruit encouraged FASB to evaluate the role of accounting standards related to consolidation and securitization. The outcome was FAS 166/167, which brought many securitizations back on balance sheets. That’s the event that forced the FDIC to revisit the safe harbor.

Whalen closes this week’s revelations with a quote from a veteran mortgage conduit risk manager who admits that maybe in toto the FDIC’s proposed rule (er, sample rule) is “overkill,” but insists the individual pieces are “pretty compelling” taken separately. “The other bank regulators and industry groups could easily negotiate a better, more streamlined deal that would help the market if they bothered to push back and participate constructively, instead of simply attacking the FDIC.”

I am sorry, but I don’t see how a white paper or a public statement is an attack. Or that the act of commenting on the ANPR is an attack. Read the comments: the dissenters use temperate language to explain why, in their view different pieces of the the FDIC’s proposal are not compelling good ideas. If instead SIFMA or one of the big banks used words like “stupid” or “selfish” or “socialistic” (for example), those would be attacks. Yelling or brandishing knives at Chairman Bair or her staff would be attacks. Making up stories about the private lives of FDIC employees would be attacks.

While we’re at it, let’s ask Federal Reserve Chairman Ben Bernanke what he qualifies as an attack. I bet he’s read and heard plenty aimed at him since he became Chairman of the Federal Reserve Board. The reasoned arguments of the detractors of the “good set of conditions” do not compare.

Keep an eye on this channel. I’ll be back – this mortgage market veteran disagrees with Whalen’s mortgage market veteran – and with a heap of the assertions made in the FDIC’s ANPR and by its supporters.

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