Earlier this year the Obama Administration proposed a major overhaul of the financial system--a plan that if passed in its entirety would touch upon almost every type of financial transaction from consumer loan to complex securitization. For the CMBS and RMBS markets, the relevant proposals included retain 5% of the credit risk that is typically sold off to investors.

Such a requirement, so the theory goes, would force originators to do better due diligence on the loans they package--and hopefully push that due diligence down through the entire credit chain from mortgage brokers to rating agencies.

Testimony before the Senate, however, shows that the financial service industry would like to see this plan further refined.

George P. Miller, executive director of the American Securitization Forum noted that while increases in regulatory capital requirements for certain securitizations may be appropriate, "a broader increase in capital requirements for securitization across the board, that is not tied to the differing risk profiles of different transactions, may produce very negative consequences for the economic viability of securitization."

He continued, "In turn, this outcome could unduly constrain the ability of financial institutions to originate and fund consumer and business credit demand, particularly as the broader economy begins to recover."

ASF is particularly concerned that linking risk-based capital requirements to accounting outcomes--particularly when those outcomes are produced by the application of accounting standards that are not themselves risk-based--would be a bad policy, he continued. "The resulting increase in regulatory capital required to be held against securitized assets held on financial institutions' balance sheets will grossly misrepresent the actual, incremental riskinherent in those assets.

As such ASF asked the US bank regulatory agencies for a six-month moratorium relating to any changes in bank regulatory capital requirements resulting from the implementation of FASB's Statements 166 and 167.

For CMBS specifically, according to testimony by Christopher Hoeffel, immediate past president of Commercial Mortgage Securities Assoc. and a current member of its executive committee, there are two points to the securitization reform proposal that are of particular concern.

They are the plan to require bond issuers or underwriters to retain at least 5% of the credit risk in any securitized asset they sell and the associated restriction on the ability of issuers to hedge the 5% retained risk.

"As such, some aspects of the government's securitization reform proposal could have the opposite and unintended result of stalling recovery efforts by making lenders less willing or able to extend loans and investors less willing or able to buy CMBS bonds--two critical components that aid in the flow of credit to the commercial real estate market," Hoeffel said.

On the other end of the spectrum, testimony provided by law professor Patricia McCoy from the Connecticut School of Law, suggested that the proposed reforms did not go far enough.

"Take the risk retention requirement, for example," she said. "It is doubtful whether the ban on hedging is even enforceable, since sometimes firms pool their risk and set hedges against several positions at once."

She continued, "More importantly, requiring risk retention does not solve the fact that banks, once they got loans off of their books through securitization, assumed that risk again by investing in toxic subprime RMBS and CDOs."

She also noted that "banks have proven adept at evading minimum capital requirements" and that "recourse provisions are only as good as a lender's solvency."

She went further, saying, "For all of these reasons, having 'skin in the game' is not enough to ensure sound loan underwriting...more is needed in the form of minimum underwriting standards."

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Testimony: 'Skin in the Game' Proposal Needs Tinkering

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