## _wp13255

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### Executive summary — main conclusions
- Securitization has costs and benefits:
  - Benefits: lowering funding costs; improving capital utilization of financial institutions; helping issuers and investors diversify risk; transforming illiquid assets into tradable securities to stimulate credit flow.
  - Costs: contribution to excessive credit growth; principal-agent problems and misaligned incentives; complexity and opaqueness hindering efficient pricing; heavy reliance on credit ratings.
- Paper’s three-stage analysis:
  - (i) role of securitization before the crisis in the context of self-reinforcing linkages across the financial sector;
  - (ii) current obstacles to efficient securitization markets;
  - (iii) suite of policy recommendations calibrated to the analysis.
- Threefold contribution:
  - Lessons learned: issuance patterns changed immediately preceding the crisis with an explosion in highly complex, synthetic products and products based on low-quality collateral; industry participants became intertwined in a self-reinforcing system of misaligned incentives (loan originators, securitization intermediaries, CRAs, and investors) which, together with easy monetary policy, culminated in systemic risk.
  - Impediments today: capital charges that may have unintended effects; asymmetric treatment of securitized assets vis-à-vis assets with similar characteristics potentially leading to new risk concentrations (particularly in covered bonds); regulatory complexity and uncertainty; operational infrastructure requiring further reform; ongoing official sector involvement in securitization and credit markets.
  - Policy recommendations: distilled into principles to preserve beneficial features of securitization while mitigating systemic risks.

### Introduction — context and motivation
- Securitization is neither inherently good nor bad; performance varied across classes of securitized assets during and after the global financial crisis (GFC).
- Channels where securitization supports the financial system and economy:
  - Lowering funding costs and economizing on capital for financial institutions.
  - Helping issuers and investors diversify and transfer risk across asset classes, geographies, industries, instruments, and credit risk.
  - Transforming pools of illiquid assets into tradable securities to assist the resumption of credit flow—relevant for many advanced economies (AEs), especially Europe where securitization volumes have regressed to decade lows (Figure 1).
- Downsides emphasized:
  - Financial accelerator effect (excessive credit growth and asset prices).
  - Principal-agent problems and misaligned incentives.
  - Complexity and opaqueness of product design.
  - Undue reliance on external credit ratings leading to investor herding.

### Revisiting the role of securitization in the crisis — key developments and interpretation
- Historical and pre-2007 developments:
  - Industry origins: GNMA securitization of U.S. government-guaranteed residential home mortgages in 1970.
  - By the turn of the century, U.S. private-label securitizations issuance stood at US$1 trillion, around five times that of Europe.
  - Between 2000 and 2007, CDO issuance increased more than six times to US$1 trillion.
  - CDO-squared issuance increased eleven-fold to around US$300 billion.
  - U.S. subprime annual issuance, 2000–06: from US$100 billion to just over US$600 billion.
  - Subprime share of total U.S. mortgage origination rose from 6.9 percent to a peak of 20.1 percent in five years.
  - Private-label residential MBS issuance in the United States: US$148 billion in 1999 to US$1.2 trillion by 2006; share of total issuance rose from 18 percent to 56 percent.
- Interpretation:
  - Securitization amplified pre-crisis excesses but was not the sole cause of the crisis.
  - A powerful self-reinforcing cycle driven by misaligned incentives among loan originators, securitization intermediaries, CRAs, and investors, combined with highly accommodative monetary policy, culminated in systemic risk.
  - Remedial actions should be targeted at each element of the securitization chain.

### Impediments to rehabilitation of securitization markets (post-crisis)
- Regulation:
  - Recent and legacy regulatory initiatives may create incentives that inadvertently encourage leveraged product structures, contribute to exploitation of “cliff effects,” or facilitate regulatory arbitrage.
  - Asymmetric capital charges—punitive charges applied to securitized assets vis-à-vis assets with similar characteristics—could result in risk concentration in other capital market instruments (such as covered bonds).
  - Regulatory complexity and uncertainty cited by industry participants as significant obstacles to resumption.
- Operational infrastructure:
  - Reforms needed in the roles of servicers, trustees, and CRAs, particularly in the systemically important U.S. mortgage market.
- Official sector involvement:
  - Central bank interventions (asset purchase programs and quantitative easing; treatment of securitized assets at discount windows) require ongoing cost/benefit monitoring.
  - Official interventions should, where possible, focus on addressing market failures rather than exerting omnipresent influence on price and availability of credit once the acute crisis stage has passed.

### Policy recommendations — objectives and orientation
- Objective: preserve beneficial features of securitization while mitigating or eliminating elements that pose a risk to long-term financial stability.
- Recommendations distilled into principles and targeted measures addressing:
  - Loan origination practices and credit metrics.
  - Securitization origination and “skin in the game.”
  - Credit rating agencies (CRAs): de-emphasize statutory references to CRA ratings; increase transparency and accountability.
  - Investors’ incentives and due diligence: reduce mechanistic reliance on ratings; require access to detailed loan-by-loan data.
  - Regulatory initiatives: avoid perverse incentives, asymmetric capital treatment, and regulatory arbitrage; ensure consistency across computational approaches.
  - Reforms to operational infrastructure (servicers, trustees, MERS, CRAs).
  - Limited, well-targeted official sector involvement focused on market failures.

### Selected key statistics and numbers (preserved verbatim)
- U.S. private-label securitizations issuance at the turn of the century: US$1 trillion.
- CDO issuance globally, 2000–2007: increased more than six times to US$1 trillion.
- CDO-squared issuance: increased eleven-fold to around US$300 billion.
- U.S. subprime annual issuance, 2000–06: from US$100 billion to just over US$600 billion.
- Subprime share of total U.S. mortgage origination: from 6.9 percent to a peak of 20.1 percent (over five years).
- Private-label residential MBS issuance in the United States: US$148 billion in 1999 to US$1.2 trillion by 2006; share of total issuance rose from 18 percent to 56 percent.
- Notes on Figure 1: Figures for 2013 are annualized based on data as at end 2013:Q2.

### Performance across securitization segments (BIS, 2011 conclusions)
- Cumulative impairment rates 1993–2011 for U.S. ABS:
  - auto loan ABS: 0.3 percent
  - credit card ABS: 0.7 percent
  - student loan ABS: 1.7 percent
  - equipment lease ABS: 5.9 percent
  - These three asset classes (auto loan, credit card, student loan) have represented 81 percent of ABS issuance in the United States since 2008.
- CLOs and structured-credit holdings:
  - Some studies documented that U.S. CLOs underlying corporate loans generally performed no worse, and in some instances better, than unsecuritized loans of comparable credit quality.
- European RMBS and ABS:
  - Standard & Poor’s data: 0.07 percent of balances underlying European RMBS (accounting for more than half of total European securitization issuance originated before June 2007) had defaulted by end-2011.
  - ABS default rates over the same period were around 30 percent.
  - During 2011 market turbulence, marked-to-market performance of European RMBS was superior to most EU sovereign debt, senior bank debt, and many covered bonds (except Pfandbriefe).

### Misaligned incentives and the self-reinforcing securitization cycle (2000–07)
- Four key elements:
  1. Loan origination: compensation tied to high loan volumes and high commission mortgages, not subsequent loan performance or suitability.
  2. Securitization: issuance of high fee-earning, complex, and opaque products soared.
  3. Credit Rating Agencies (CRAs): some securitized products awarded higher ratings than fundamentals suggested; correlations underestimated; “ratings shopping”.
  4. Investors: accommodative monetary policy intensified the search for yield; banks retained contingent exposure to structured investment vehicles with high rollover risk.
- Role of nonbank origination and appraiser incentives:
  - Movement of mortgage origination from regulated banking sector to nonbanks (notably unregulated independent mortgage brokers) contributed to deteriorating lending standards.
  - Appraisers incentivized by repeat business to err high, supporting larger mortgages and cash-out refinancings.

### Appendix 3 — U.S. and European mortgage securitization markets (highlights)
- Interlinkage reviews cited: Brunnermeier, 2009; Mian and Sufi, 2009; Keys and others, 2010.
- U.S. mortgage origination:
  - “more than 45 percent” of high-cost first-time mortgages were originated by independent mortgage companies in 2006.
  - Sixty-eight percent of all U.S. mortgage loans were originated by brokers in 2004.
  - 72 percent of all subprime loans in the second half of 2006 were originated by brokers.
- Documentation and underwriting weaknesses:
  - Rise in low- and no-documentation loans in subprime and Alt-A segments; income/assets often overstated or not verified.
- Originate-to-Distribute implications:
  - Originators often had little or no economic interest (“skin in the game”), weakening incentives to ensure borrower repayment capacity.
  - Broker/dealers used structuring techniques to transform low-quality collateral into highly rated securities; re-securitizations (ABS → CDOs → CDO-squares) and synthetic securitizations expanded rated supply.
  - Return on equity for ABS/RMBS businesses estimated in the mid-to-high double digits; Lehman Brothers and Morgan Stanley derived around 45 percent of their profits from residential mortgage, ABS, and commercial real estate business lines in 2006/07.
  - CDO sector expanded dramatically by some US$600 billion between 2000 and 2006.
- Legal, tax, and accounting frameworks shaped continental European markets; Germany’s 2005 Refinancing Register cited as an example of infrastructure facilitating transfers.

### Box 2 — Overview of the BCBS (2012) proposals on capital charges (summary)
- Objective: make capital requirements more prudent and risk-sensitive and reduce reliance on external credit ratings.
- Replaces Basel II SA and IRB approaches for securitization with two hierarchies (Hierarchy A and Hierarchy B); banks retain choice among methodologies but technical details generally result in more punitive capital charges for securitization compared to Basel II.
- A proportion of junior tranches of any securitization must carry a 1,250 percent risk weight under several approaches.
- New methods (key features):
  - MSFA: loan-level data, estimates of correlations, PD, EAD, LGD; more conservative calibration.
  - RRBA: requires at least two eligible credit ratings; does not use loan pool data; highest potential for structuring highly leveraged transactions among the new approaches.
  - SSFA: calibrates capital requirements based on weighted-average capital requirement of underlying exposure using SA capital charges; assigns risk weights by subordination level and tranche thickness.
  - BCRA: fallback approach; capital charge is min(1,250 percent, underlying pool’s SA capital charge divided by detachment point).
- Perverse incentives and capital arbitrage:
  - SSFA, MSFA, and BCRA reduce but do not eliminate incentives for leverage; capital arbitrage may persist above tranches subjected to the 1,250 percent risk weight.
  - Example under SSFA: moving one level beyond the most senior tranche leads to a 28-fold increase in risk weight, from 20 to 567 percent.
- Cliff effects:
  - SSFA and MFSA use continuous functions mitigating cliff effects; RRBA remains dependent on credit ratings and can produce cliff effects (e.g., moving from AAA to AA).
- Illustrative numerical outcomes (selected figures from Tables; preserved verbatim):
  - Table 2 (U.S. High-Quality Mortgage Deal, US$100 million transaction; underlying loan risk weight = 50 percent implying underlying loans’ capital charge of 4 percent = US$4 million):
    - Total Capital Charge ($mn) on $100mn Deal under methods: SA = 2.95; IRB = 1.93; SSFA = 7.05; RRBA (maturity=1) = 4.24; RRBA (maturity=5) = 7.21; BCRA = 10.77.
    - Multiple of Capital Charge on Deal vis-à-vis if Loans Held On-Balance Sheet: SA = 0.74; IRB = 0.48; SSFA = 1.76; RRBA (maturity=1) = 1.06; RRBA (maturity=5) = 1.80; BCRA = 2.69.
  - Table 3 (U.S. Consumer Deal, US$100 million transaction; underlying loan risk weight = 75 percent implying underlying loans’ capital charge of 6 percent = US$6 million):
    - Total Capital Charge ($mn) on $100mn Deal under methods: SA = 17.74; IRB = 16.22; SSFA = 10.26; RRBA (maturity=1) = 28.49; RRBA (maturity=5) = 34.86; BCRA = 30.34.
    - Multiple of Capital Charge on Deal vis-à-vis if Loans Held On-Balance Sheet: SA = 2.96; IRB = 2.70; SSFA = 1.71; RRBA (maturity=1) = 4.75; RRBA (maturity=5) = 5.81; BCRA = 5.06.
  - BCBS (2012) proposals can increase total capital charges on a US$100 million securitization deal to a range between US$10.26 million and US$34.86 million in the hypothetical examples—i.e., 1.7 and 5.8 times higher than on the underlying loans (US$6 million) in the consumer-deal example.
- Cross-jurisdiction inconsistencies and potential regulatory arbitrage highlighted; SSFA could in some cases result in higher capital charges than RRBA for mezzanine tranches.
- Asymmetric treatment vs. covered bonds:
  - EU CRD: covered bonds meeting certain criteria attract a 10 percent risk weight—half of the Basel minimum floor.
  - Solvency II proposed spread-risk factors for five-year-or-less durations: AAA–rated securitized tranches = 7; covered bonds = 0.7.
  - LCR and NSFR examples show materially different haircut and weight treatments for covered bonds versus similarly rated securitizations.
- Systemic consequences:
  - Higher capital and liquidity charges for securitized assets relative to similar instruments may encourage migration into the non-bank financial system (shadow banking), concentrate risk elsewhere, and reduce investor base in regions like Europe.

### Regulatory overlap, operational infrastructure, and central bank treatment (highlights)
- Regulatory overlap and exemptions:
  - Hedge funds, private equity funds, enhanced cash funds, and many SPVs make use of exemptions.
  - Regulated institutions can own up to three percent of the capital of covered funds but face further restrictions; prohibited from providing loans, letters of credit, or guarantees to such funds.
  - Dodd-Frank Act extends CFTC regulations under the CEA to essentially all entities that use OTC swaps, including securitization vehicles—raising registration and compliance costs.
- Operational infrastructure deficiencies:
  - Servicers and trustees overwhelmed during the U.S. housing crisis; business models calibrated to “normal times” left them under-resourced in stress.
  - MERS led to instances where registered owner did not match economic owner, resulting in litigation and discontinued foreclosure practices in MERS name.
- CRA practices post-crisis:
  - CRAs tightened requirements (sovereign-ratings caps on securitizations; minimum ratings for swap counterparties and cash depositaries), making securitizations more difficult and costly.
- Central bank asset purchases and discount window treatment:
  - U.S. Federal Reserve QE3 (September 2012) included purchases of US$40 billion of agency MBS; monthly purchases of US$45 billion of treasury bonds added in December 2012.
  - Some U.S. direct intervention programs expired; TALF loans extended will mature by March 2015.
  - Examples of inconsistent haircut treatment (preserved verbatim):
    - United States: 5–10 year duration covered bonds, in the AA to BBB range, and (jumbo) German Pfandbriefe and corporate bonds receive a 7 percent haircut; ABS with same duration and credit rating subject to a 14 percent haircut.
    - Euro area: 0–1 year duration jumbo covered bonds, covered bank bonds, and conventional corporate debt, in the A to AAA rating category, subject to a 1 percent haircut; eligible ABS with same maturity and credit rating receive a 10 percent haircut.
    - United Kingdom: 1–3 year duration covered bonds in the A-minus or above category subject to a 14 percent haircut; ABS backed by credit cards, student loans, consumer loans, and auto loans face a 17 percent charge; CMBS of similar rating and duration face a 27 percent haircut.
  - Share of ABS in total repo activity within the ECB declined from 28 percent in 2008 to 16 percent in 2012; use of ABS in repos with the ECB declined 21 percent in absolute terms in the two years to end-2012, while use of covered bonds as collateral increased 72 percent.
  - ECB announced steps to level the playing field, including reduction in haircuts for ABS eligible under permanent and temporary Eurosystem collateral framework (example: from 16 to 10 percent).

### Policy recommendations — structure and select items (preserving source wording)
- The paper presents 29 policy recommendations (“core principles”):
  - 16 recommendations in Section A aimed at addressing factors that contributed to the crisis and mitigating the risk of another adverse self-reinforcing cycle.
  - 13 recommendations in Section B aimed at addressing obstacles to the resumption of a robust securitization market.
- Selected recommendations and proposals (preserved phrasing):
  - Improve the quality of underlying loan origination practices; risk-based frameworks defining regulatory provisions and capital could provide incentives that reinforce solid origination practices.
  - Establishment of the Consumer Financial Protection Bureau (CFPB) with comprehensive powers to regulate and supervise is welcomed, particularly as it can bring certain nonbanks under its supervision when their activities pose risks to consumers.
  - Retention of some originator risk (“skin in the game”) can help align incentives but is not a panacea; focus should be on incentives across the securitization chain.
  - Regulators should de-emphasize the role of conventional credit ratings; removal of statutory references to CRA ratings in the EU and the United States is welcomed.
  - Publish revenue shares for each rated entity in buckets (below 0.5 percent, 0.5–2 percent, 2–5 percent, and above); separate analysts and sales departments; publish ratings processes and remuneration schedules.
  - Require ongoing disclosure of all loan-relevant data by loan originators and securitization arrangers; full transparency over ratings and quality control: disclose numbers of rejected loans and nature of material deficiencies.
  - Encourage investors to reduce reliance on credit ratings by revising investment mandates, eliminating forced selling upon downgrade, and ensuring access to detailed loan-by-loan data.
  - Consider exemptions from “covered fund” designation under the Volcker Rule for standard securitization vehicles; CFTC to consider reinstating CEA exemptions for highly sophisticated investors for non-synthetic securitizations.
  - Clarify tranche “maturity” definition under BCBS (2012) proposals; regulators could test simple models based on conservative assumptions.
  - Strengthen legal foundation for modern electronic mortgage registration systems to minimize legal ambiguities and litigation costs.
  - Ongoing evaluation of costs and benefits of central bank asset purchase programs and loan programs; central banks should re-examine severe discount-window treatment of securitized assets vis-à-vis similar-risk assets.

### Appendix and background material (selected historical and mechanical points)
- Appendix I (1970–1999): industry origins—GNMA pass-through in 1970; FHLMC began securitizing in 1971; FNMA in 1981; first private-label mortgage pass-through by Bank of America in 1977; first private-label ABS by Sperry Univac in 1985.
- Appendix II (mechanics and participants): originator; arranger; SPV (bankruptcy-remote); investors; CRAs; quality control firms; servicer; trustee; lawyers; guarantor; asset manager; custodian.
- Appendix III (U.S. vs continental Europe): GSEs and government guarantees dominate U.S. mortgage market; differences in originate-to-distribute prevalence (U.S. brokers and nonbanks vs. Europe’s banking origination); issuance of arbitrage ABS-CDOs largely a U.S. phenomenon (CDOs made up US$315 billion in 2006, 54 percent ABS-CDOs; cash ABS-CDO volumes US$109 billion by 2006; synthetic CDOs expanded from US$14 billion to US$54 billion in 2006).

*Source: _wp13255 (IMF working paper excerpts provided).*

### Executive Summary ......................................................................................................

### _wp13255 - Executive Summary ......................................................................................................

### Executive summary — main conclusions
- Securitization has costs and benefits: potential benefits include lowering funding costs, improving capital utilization of financial institutions, helping issuers and investors diversify risk, and transforming illiquid assets into tradable securities to stimulate credit flow.
- Potential costs include: contribution to excessive credit growth; principal-agent problems and misaligned incentives; complexity and opaqueness of products that hinder efficient pricing; heavy reliance on credit ratings.
- The paper’s analysis proceeds in three stages: (i) examine the role of securitization before the crisis in the context of self-reinforcing linkages across the financial sector; (ii) identify current obstacles to efficient securitization markets; (iii) propose a suite of policy recommendations calibrated to the analysis.
- Threefold contribution:
  - Lessons learned: issuance patterns changed dramatically immediately preceding the crisis with an explosion in highly complex, synthetic products and products based on low-quality collateral; industry participants became intertwined in a self-reinforcing system of misaligned incentives (loan originators, securitization intermediaries, credit rating agencies (CRAs), and investors) which, together with easy monetary policy, culminated in systemic risk.
  - Impediments today: capital charges that may have unintended effects; asymmetric treatment of securitized assets vis-à-vis assets with similar characteristics potentially leading to new risk concentrations (particularly in covered bonds); regulatory complexity and uncertainty; operational infrastructure that requires further reform; ongoing official sector involvement in securitization and credit markets.
  - Policy recommendations: distilled into a set of principles to preserve beneficial features of securitization while mitigating systemic risks.

### Introduction — context and motivation
- Securitization is neither inherently good nor bad; performance varied markedly across classes of securitized assets during and after the global financial crisis (GFC).
- Potential channels where securitization supports the financial system and economy include:
  - Lowering funding costs and economizing on capital for financial institutions.
  - Helping issuers and investors diversify and transfer risk across asset classes, geographies, industries, instruments, and credit risk.
  - Transforming pools of illiquid assets into tradable securities to assist the resumption of credit flow—relevant for many advanced economies (AEs), especially Europe where securitization volumes have regressed to decade lows (Figure 1).
- Downsides highlighted include the financial accelerator effect (excessive credit growth and asset prices), principal-agent problems and misaligned incentives, complexity and opaqueness of product design, and undue reliance on external credit ratings leading to investor herding.

### Revisiting the role of securitization in the crisis — key developments (2000s in historical perspective)
- Historical expansion:
  - Securitization broadened in size and scope over three decades up to the turn of the century.
  - The industry originated in 1970 with GNMA securitization of U.S. government-guaranteed residential home mortgages.
  - By the turn of the century, U.S. private-label securitizations issuance stood at US$1 trillion, around five times that of Europe.
- Dramatic pre-2007 changes:
  - Between 2000 and 2007, issuance of collateralized debt obligation (CDO) increased more than six times to US$1 trillion.
  - Issuance of CDO-squared products increased eleven-fold to around US$300 billion.
  - In the United States, annual issuance volumes in the subprime mortgage segment increased from US$100 billion to just over US$600 billion over 2000–06.
  - Subprime share of total U.S. mortgage origination rose from 6.9 percent to a peak of 20.1 percent in five years.
  - Most subprime mortgages were adjustable-rate mortgages with two- or three-year fixed-rate periods and deferral of principal repayment up to five years.
  - Private-label residential MBS issuance in the United States increased from US$148 billion in 1999 to US$1.2 trillion by 2006, increasing its share of total issuance from 18 percent to 56 percent.
- Interpretation:
  - Securitization amplified pre-crisis excesses but was not the sole cause of the crisis.
  - A powerful self-reinforcing cycle driven by misaligned incentives among loan originators, securitization intermediaries, CRAs, and investors, combined with highly accommodative monetary policy, culminated in systemic risk.
  - Remedial actions should be targeted at each element of the securitization chain.

### Impediments to rehabilitation of securitization markets (post-crisis)
- Regulation:
  - Some recent and legacy regulatory initiatives may create incentives that inadvertently encourage leveraged product structures, contribute to the exploitation of “cliff effects,” or facilitate regulatory arbitrage.
  - Imposition of asymmetric capital charges—where relatively punitive charges apply to securitized assets vis-à-vis assets with similar characteristics—could result in risk concentration in other capital market instruments (such as covered bonds).
  - Regulatory complexity and uncertainty are cited by industry participants as significant obstacles to resumption of securitization markets.
- Operational infrastructure:
  - Reforms needed in the roles of servicers, trustees, and CRAs, particularly in the systemically important U.S. mortgage market.
- Official sector involvement:
  - Central bank interventions (asset purchase programs and quantitative easing; treatment of securitized assets at discount windows) require ongoing cost/benefit monitoring.
  - Official interventions should, where possible, focus on addressing market failures rather than exerting omnipresent influence on the price and availability of credit once the acute crisis stage has passed.

### Policy recommendations — objectives and orientation
- Objective: preserve beneficial features of securitization while mitigating or eliminating elements that pose a risk to long-term financial stability.
- Recommendations are distilled into principles and targeted measures addressing:
  - Loan origination practices.
  - Securitization origination.
  - Credit rating agencies.
  - Investors’ incentives and due diligence.
  - Regulatory initiatives to avoid perverse incentives, asymmetric capital treatment, and regulatory arbitrage.
  - Reforms to operational infrastructure (servicers, trustees, CRAs).
  - Limited, well-targeted official sector involvement focused on market failures.

### Selected key statistics and numbers cited in the Executive Summary and Introduction
- U.S. private-label securitizations issuance at the turn of the century: US$1 trillion.
- CDO issuance globally, 2000–2007: increased more than six times to US$1 trillion.
- CDO-squared issuance: increased eleven-fold to around US$300 billion.
- U.S. subprime annual issuance, 2000–06: from US$100 billion to just over US$600 billion.
- Subprime share of total U.S. mortgage origination: from 6.9 percent to a peak of 20.1 percent (over five years).
- Private-label residential MBS issuance in the United States: US$148 billion in 1999 to US$1.2 trillion by 2006; share of total issuance rose from 18 percent to 56 percent.
- Notes on Figure 1: Figures for 2013 are annualized based on data as at end 2013:Q2.

*Source: _wp13255 - Executive Summary (IMF working paper, Executive Summary and Introduction as provided).*

### conclusions about other segments of the securitization market (BIS, 2011).

### conclusions about other segments of the securitization market (BIS, 2011)

### Performance of different securitization products
- Cumulative impairment rates from 1993–2011 for U.S. ABS:
  - auto loan ABS: 0.3 percent
  - credit card ABS: 0.7 percent
  - student loan ABS: 1.7 percent
  - equipment lease ABS: 5.9 percent
  - These three asset classes (auto loan, credit card, student loan) have represented 81 percent of ABS issuance in the United States since 2008.
- Evidence on CLOs and structured-credit holdings:
  - Some studies documented that U.S. collateralized loan obligations (CLOs) underlying corporate loans generally performed no worse, and in some instances better, than unsecuritized loans of comparable credit quality.
  - Other studies found no support for the idea that U.S. leveraged-buyout deals held in structured credit vehicles were of a lower quality or performed worse than buyout deals not subsequently involved with securitization.
- European RMBS and ABS experience:
  - Standard & Poor’s data show 0.07 percent of the balances underlying European RMBS (accounting for more than half of total European securitization issuance originated before June 2007) had defaulted by end-2011.
  - By contrast, ABS default rates over the same period were around 30 percent.
  - During 2011 market turbulence, marked-to-market performance of European RMBS was superior to most EU sovereign debt, senior bank debt, and many covered bonds (with the exception of Pfandbriefe).

### Explanations for divergent performance across securitized assets
- Structural and collateral differences cited as relevant factors:
  - Most ABS have much shorter amortization periods than conventional mortgages and, hence, carry significantly lower risk of principal loss.
  - Home prices tend to appreciate over the long term (at least in nominal terms); by contrast, automobiles and other physical property that frequently secure ABS do not—this can affect recovery-value estimation incentives for housing-related securities.
  - Non-house collateral is fungible (e.g., a car can easily be repossessed and sold with relatively lower frictional costs than housing).
  - In some cities, eviction of delinquent mortgagors can take significant periods (for instance, around three and half years in New York City), whereas delinquent borrowers using other forms of credit (car loans, credit card debt) face much shorter periods of forbearance. Stressed borrowers may prioritize repayment of car loans and credit card debt ahead of mortgage payments because use of those facilities would otherwise be cut shortly after default.

### Taxonomy and funding characteristics of securitization markets (overview points)
- Underlying assets and transaction types (select highlights from taxonomy):
  - Funding transactions: underlying assets include loans, legal rights to specific assets (e.g., leased equipment), and rights to specific cash flows (e.g., cash flows from equipment leases).
  - Non-funding transactions: underlying assets include securities, subordinated debt, SME loans, or obligations to make payments on derivatives contingent on certain events (e.g., CDS).
  - Noted instruments and acronyms: ABCP; ABS; ABS-CDO; CBO; CDO; CDS; CLO; CMBS; FNMA; GNMA; GSE; KfW; MBS; RMBS; SIV; SME; TruPS.
- Specific program and regulatory observations:
  - KfW’s PROVIDE transactions had collateral comprising mortgages from a single country subject to restrictions on LTVs, debt-to-income ratios, and other loan characteristics; most tranches were assigned a rating.
  - TruPS are unsecured, subordinated debentures that could be counted as Tier 1 capital; Dodd-Frank Act is restricting their ability to count towards Tier 1 capital, except for banks with less than US$500 million of assets.

### Misaligned incentives and the self-reinforcing securitization cycle (2000–07)
- Four key elements of the self-reinforcing securitization chain:
  1. Loan origination: compensation tied to high loan volumes and high commission mortgages, not subsequent loan performance or suitability.
  2. Securitization: issuance of high fee-earning, complex, and opaque products soared, requiring advanced financial engineering and large quantities of underlying loans.
  3. Credit Rating Agencies (CRAs): some securitized products were awarded higher ratings than fundamentals suggested; correlations were underestimated; "ratings shopping" may have resulted in upwardly biased ratings.
  4. Investors: accommodative monetary policy intensified the search for yield; banks retained contingent exposure to structured investment vehicles with high rollover risk.
- Role of loan origination in creating systemic risk:
  - Movement of mortgage origination from regulated banking sector to nonbanks (notably unregulated independent mortgage brokers) contributed to deteriorating lending standards.
  - Compensation practices and product suitability concerns:
    - Compensation tied to origination volumes and sale of high-fee products led to predatory lending and a sharp decline in lending standards.
    - Appraisers, incentivized by repeat business from originators, were incentivized to err on the higher side of valuations, supporting larger initial mortgages and cash-out refinancings.

*Source: _wp13255 - conclusions about other segments of the securitization market (BIS, 2011).*

### Appendix 3 provides a description of the U.S. and European mortgage securitization markets. For reviews of the

### _wp13255 - Appendix 3 provides a description of the U.S. and European mortgage securitization markets. For reviews of the

### Overview and context
- Reviews cited for interlinkages between the U.S. residential mortgage markets and the wider credit crisis: Brunnermeier, 2009; Mian and Sufi, 2009; and Keys and others, 2010.
- U.S. Home Mortgage Disclosure Act data: in 2006 more than 45 percent of high-cost first-time mortgages were originated by independent mortgage companies (Bernanke, 2008).
- FDIC statement: “The FDIC faces significant challenges associated with identifying, assessing, and addressing the risks posed to FDIC-supervised institutions and consumers by predatory lending,” (FDIC, 2006).

### Lending standards, documentation, and credit/asset price feedbacks
- Documentation practices:
  - Meaningful rise in low- and no-documentation loans in the subprime and Alt-A segments.
  - Income and/or asset positions often overstated and/or not verified (Federal Bureau of Investigation, 2004).
- Credit and asset prices:
  - Credit amplified real estate boom-bust cycles; unrealized gains used as collateral intensified borrowing and exposure.
  - Deceleration in home price appreciation caused problems for some borrowers, notably in the United States starting in 2006.

### Securitization developments and amplification of the crisis
- Originate-to-Distribute model:
  - Originators often had little or no economic interest (“skin in the game”), weakening incentives to ensure borrower repayment capacity.
  - Poor loan origination standards noted as more critical than the model itself; some originators in Europe and U.S. retained exposure via tranche ownership or contingent funding lines.
- Financial engineering and demand for low-quality loans:
  - Broker/dealers used structuring techniques to transform low-quality collateral into highly rated securities.
  - Re-securitizations (ABS → CDOs → CDO-squares) and synthetic securitizations expanded supply of rated structured bonds.
  - Return on equity for ABS/RMBS businesses was estimated to be in the mid-to-high double digits; Lehman Brothers and Morgan Stanley derived around 45 percent of their profits from residential mortgage, ABS, and commercial real estate business lines in 2006/07.
  - CDO sector expanded dramatically by some US$600 billion between 2000 and 2006.
- Broker/dealer leverage:
  - SEC “uniform net capital rule” exemption (2004) permitted large broker/dealers (net capital in excess of US$5 billion) to use internal models to compute haircuts and capital requirements; commentators faulted the SEC for enabling increased leverage (GAO, 2004; Coffee, 2008; Blinder, 2009; Stiglitz, 2009), though disputes exist (Cohan, 2012).
- Risk concentrations:
  - Hundreds of billions of dollars of structured products sold to SIVs, ABCP conduits, and SIV-lites, creating maturity and rollover risk due to short-duration liabilities.
  - Banks often retained explicit or implicit contingent exposures; examples cited: Citigroup (US$49 billion of SIV assets) and State Street Bank (US$23 billion of ABCP conduit assets).
  - Under Basel 2.5, capital charge for a credit line to a conduit increased to 50 percent of the charge applicable when the facility is funded, up from 20 percent previously.

### Representations & warranties (RWs) and quality control failures
- RWs defined obligations of originators; enforcement problems included:
  - Difficulty of compliance verification.
  - Third-party quality control firms using non-representative samples.
  - Conflicts of interest for quality control firms paid by issuing banks, creating pressure to minimize findings of substandard mortgages.
  - Limited investor access to quality-control-generated information; investors often relied on data provided by arrangers.

### Credit rating agencies (CRAs): market structure, incentives, and methodology problems
- Market concentration and dominance:
  - The “Big Three” (S&P, Moody’s, Fitch) account for 97 percent of all outstanding credit ratings (2012 SEC report).
  - Market shares reported: S&P (42.3 percent), Moody’s (36.9 percent), Fitch (17.9 percent).
- Misaligned incentives:
  - NRSROs operating under the issuer-pay model account for approximately 99 percent of all outstanding NRSRO credit ratings.
  - S&P derived around 40 percent of its revenues from structured products (Westlaw, 2013).
  - Moody’s earned US$881 million from structured finance in 2006—more than its total business revenues for 2001.
  - Allegations of “ratings shopping” and pressure to soften ratings criteria (Council on Foreign Relations, 2013); U.S. Department of Justice lawsuit described apparent efforts to increase business volumes by softening ratings.
- Methodology weaknesses:
  - Ratings for complex structured products relied on sensitive models and benign historical home-price samples; correlations were underestimated.
  - In 2007 Moody's downgraded 83 percent of the US$869 billion in mortgage securities it had rated triple-A in 2006.
  - Programming and modeling errors were identified in some ratings work.
- Issuer-CRA interactions:
  - Broker/dealers and arrangers collaborated with CRAs to engineer deal features to obtain desired ratings; ratings shopping across major agencies was used by issuers.
- Excessive reliance by regulators and investors:
  - Basel framework made CRA ratings integral to capital calculations; banks used CRA ratings for ABS and RMBS capital requirements.
  - Many investors relied excessively on external ratings due to mandates and limited internal analytic capacity.

### Investors, leverage, and market dynamics
- Leveraged investors and structures:
  - Growth of SIVs, SIV-lites, and ABCP conduits financed largely in CP and repo markets; assets had weighted average life around three years (common effective range two to five years).
  - Specialist hedge funds focused on structured fixed-income products increased in number; leverage and maturity mismatches amplified rollover and liquidity risk.
  - Market stigma and lack of transparency led to uncertainty premia, fire sales, and evaporation of liquidity beginning in 2007.
- Institutional investors:
  - “Search for yield” by pension funds and insurers driven by: low government yields post-2001/02 recession; inflows of emerging market foreign exchange reserves (international reserves increased from an average of 12 percent to 20 percent of world GDP between 2000 and 2007); collapse of corporate debt issuance by nearly 50 percent in U.S. and Europe as corporate sector deleveraged; and pension funds’ asset-liability strategies after 2000–02 equity declines.
  - Some investors materially increased fixed-income allocations; example: Boots Pensions Ltd. moved to a 100 percent bond allocation.
- Misconceptions about diversification:
  - Structured credit performance compared favorably to corporate credit 1998–02 and to equities 2000–03, leading investors to extend along risk/illiquidity spectrum.
  - Volatility and correlation assumptions in investor models proved overly optimistic.

### Regulatory environment and impediments to securitization recovery
- Three prominent regulatory concerns in post-crisis re-regulation:
  - Regulatory measures could create incentives encouraging leveraged product structures, capital arbitrage, exploitation of “cliff effects,” or regulatory arbitrage.
  - Asymmetric capital charges that are punitive toward securitized assets vis-à-vis similar assets could shift risk concentration to other capital market sectors (e.g., covered bonds).
  - Regulatory complexity and uncertainty are cited as obstacles to resumption of growth-supportive securitization markets.
- Capital requirement initiatives:
  - U.S. proposed simplified supervisory formula approach (SSFA) in June 2012 to calculate risk weights of securitization holdings without reference to external credit ratings (compliance with Section 939A of the Dodd-Frank Act).
  - Basel Committee on Banking Supervision (BCBS) December 2012 consultative document proposed substantial revisions to capital requirements for securitized assets; BCBS commissioned a quantitative impact study following the 2012 proposals.
  - Industry response included 42 separate submissions during a three-month comment window from diverse market participants.

### Key numerical and factual points (extracted verbatim)
- “more than 45 percent” (high-cost first-time mortgages by independent mortgage companies in 2006).
- Broker/dealers with net capital in excess of US$5 billion affected by the 2004 SEC exemption.
- Lehman Brothers and Morgan Stanley derived around 45 percent of their profits from residential mortgage, ABS, and commercial real estate business lines in 2006/07.
- CDO sector expansion: some US$600 billion between 2000 and 2006.
- Moody's downgraded 83 percent of the US$869 billion in mortgage securities it had rated triple-A in 2006 (in 2007).
- Examples of bank contingent exposures: Citigroup (US$49 billion of SIV assets) and State Street Bank (US$23 billion of ABCP conduit assets).
- “Big Three” concentration: 97 percent of all outstanding credit ratings (2012 SEC report); market share S&P (42.3 percent), Moody’s (36.9 percent), Fitch (17.9 percent).
- NRSRO issuer-pay model: approximately 99 percent of all outstanding NRSRO credit ratings.
- S&P derived around 40 percent of its revenues from structured products (Westlaw, 2013).
- Moody’s structured finance revenues in 2006: US$881 million.
- International reserves held by emerging market economies increased from an average of 12 percent to 20 percent of world GDP between 2000 and 2007.
- Under Basel II examples: mortgage retail loans could attract a 35 percent risk weight; retail loans not secured by real estate could attract 75 percent; securitization tranches could be “Deducted” (subtracted from capital).

*Source: Appendix 3 excerpt from the IMF working paper _wp13255 (provided content).*

### Box 2. Overview of the BCBS Proposals on Capital Charges

### Box 2. Overview of the BCBS Proposals on Capital Charges

### Overview of BCBS (2012) objectives and changes
- Aim: make capital requirements more prudent and risk-sensitive and reduce reliance on external credit ratings.
- Replaces Basel II SA and IRB approaches for securitization with two alternative hierarchies (Hierarchy A and Hierarchy B).
- Banks retain choice among methodologies, but technical details generally result in more punitive capital charges for securitization compared to Basel II.
- A specific proportion of junior tranches of any securitization must carry a 1,250 percent risk weight under several approaches.

### New hierarchies and choice of methods
- Hierarchy A (for IRB-capable banks):
  - IRB-banks shall use the Modified Supervisory Formula Approach (MSFA) to the extent possible.
  - If MSFA cannot be used, banks must use either the Revised Ratings-Based Approach (RRBA) or the Simplified Supervisory Formula Approach (SSFA).
  - If RRBA or SSFA cannot be applied, fallback is Backstop Concentration Ratio Approach (BCRA).
- Hierarchy B:
  - Banks may employ the RRBA or, depending on jurisdictional choice, the MSFA or SSFA, but these are limited to high-quality senior tranches.
  - For all other tranches, IRB-banks must use the broad-based concentration ratio approach based on calculated capital requirements for the underlying securitized assets.

### Modified Supervisory Formula Approach (MSFA / MFSA)
- Uses highly granular, loan-level data; requires estimates of asset value correlations, probability of default (PD), exposure at default (EAD), and loss given default (LGD) to determine K_IRB.
- Modifies Basel II SFA by accounting for potential future credit deterioration due to longer maturities, and depends on credit enhancement and tranche thickness.
- Calibrated more conservatively than Basel II SFA and considered highly technical and complex.
- A specific proportion of junior tranches must carry a 1,250 percent risk weight; that proportion is a function of investors’ internal model-derived capital charges for the underlying collateral.

### Revised Ratings-Based Approach (RRBA)
- Replaces Basel II Ratings-Based Approach (RBA) and SFA.
- Requires at least two eligible credit ratings for securitization exposures.
- Incorporates seniority and maturity of a tranche and tranche thickness as determinants of capital charges.
- Does not use loan pool data to determine capital requirements.
- RRBA offers the highest potential for structuring highly leveraged transactions among the new approaches.

### Simplified Supervisory Formula Approach (SSFA)
- Calibrates capital requirements based on the weighted-average capital requirement of the underlying exposure using SA capital charges.
- Assigns risk weights according to subordination level, tranche thickness (adjusted for delinquencies), and a calibration parameter to reduce cliff effects.
- Part of the junior tranches must carry a 1,250 percent risk weight; the proportion is a function of the underlying collateral assets’ risk weights.

### Backstop Concentration Ratio Approach (BCRA)
- Fallback approach used before imposing the maximum risk weight of 1,250 percent.
- Uses capital charges for underlying pools as determined under the SA, reflecting senior or non-senior position of a tranche.
- Calculates capital charge as the minimum of either (i) 1,250 percent or (ii) the underlying pool’s capital charge under the standardized approach, divided by the “detachment point”.

### Perverse incentives: leverage and capital arbitrage
- Basel II permitted structuring of highly leveraged transactions because of large differences in capital requirements between junior and senior tranches and engineered ratings.
- The SSFA, MFSA, and BCRA reduce but do not eliminate incentives for leverage by imposing 1,250 percent risk weight on a fixed proportion of junior tranches (proportion varies by approach).
- Capital arbitrage may persist above tranches subjected to the 1,250 percent risk weight: originators could optimize tranche sizes to minimize capital charges and sell junior tranches to non-bank investors.
- Example under SSFA: moving one level beyond the most senior tranche leads to a 28-fold increase in risk weight, from 20 to 567 percent.

### Cliff effects
- SSFA and MFSA use continuous functions and do not incorporate ratings as inputs, mitigating cliff effects (small input changes lead to smooth changes in capital charges).
- RRBA remains dependent on credit ratings and can produce cliff effects from rating changes, though RRBA mitigates cliff effects through preferential treatment of senior tranches.
- Under RRBA, relative changes in risk weights between letter ratings are generally smaller among non-senior tranches than under the SA; however, a notable cliff effect exists moving from AAA to AA under the new proposals.

### Illustrative numerical outcomes (selected figures from Tables)
- Table 2 (U.S. High-Quality Mortgage Deal, US$100 million transaction; underlying loan risk weight = 50 percent implying underlying loans’ capital charge of 4 percent = US$4 million):
  - Total Capital Charge ($mn) on $100mn Deal under methods: SA = 2.95; IRB = 1.93; SSFA = 7.05; RRBA (maturity=1) = 4.24; RRBA (maturity=5) = 7.21; BCRA = 10.77.
  - Multiple of Capital Charge on Deal vis-à-vis if Loans Held On-Balance Sheet: SA = 0.74; IRB = 0.48; SSFA = 1.76; RRBA (maturity=1) = 1.06; RRBA (maturity=5) = 1.80; BCRA = 2.69.
- Table 3 (U.S. Consumer Deal, US$100 million transaction; underlying loan risk weight = 75 percent implying underlying loans’ capital charge of 6 percent = US$6 million):
  - Total Capital Charge ($mn) on $100mn Deal under methods: SA = 17.74; IRB = 16.22; SSFA = 10.26; RRBA (maturity=1) = 28.49; RRBA (maturity=5) = 34.86; BCRA = 30.34.
  - Multiple of Capital Charge on Deal vis-à-vis if Loans Held On-Balance Sheet: SA = 2.96; IRB = 2.70; SSFA = 1.71; RRBA (maturity=1) = 4.75; RRBA (maturity=5) = 5.81; BCRA = 5.06.
- The BCBS (2012) proposals can increase total capital charges on a US$100 million securitization deal to a range between US$10.26 million and US$34.86 million in the hypothetical examples—i.e., 1.7 and 5.8 times higher than on the underlying loans (US$6 million) in the consumer-deal example.

### Regulatory arbitrage and cross-jurisdiction inconsistency
- The inconsistency between SSFA and RRBA raises potential for regulatory arbitrage among jurisdictions choosing between approaches.
- SSFA could in some cases result in higher capital charges than RRBA, particularly for mezzanine tranches.
- BCBS acknowledges capital charges for similar exposures could vary substantially depending on methodological choice.

### Asymmetric capital and liquidity treatment vs. covered bonds
- EU CRD: covered bonds meeting certain criteria attract a 10 percent risk weight—half of the Basel minimum floor—significantly lower than comparable securitization exposures.
- Solvency II proposed spread-risk factors for five-year-or-less durations: AAA–rated securitized tranches = 7; covered bonds = 0.7 (implying capital requirement for securitized assets could be ten times higher than covered bonds with equivalent market value and duration).
- LCR treatment (examples):
  - Covered bonds with AA-rating or higher classified as Level 2A asset with a haircut of 15 percent.
  - RMBS classified as Level 2B asset with a haircut of 25 percent and must meet conditions (e.g., full recourse, LTV ≤ 80 percent) that many RMBS do not satisfy, making them ineligible for inclusion in LCR.
- NSFR treatment:
  - Highly rated covered bonds and corporate bonds receive a 20 percent weight when calculating “long-term assets” for NSFR.
  - Similarly rated securitizations are subject to a 100 percent charge.

### Systemic and market consequences
- Higher capital and liquidity charges for securitized assets relative to similar instruments (e.g., covered bonds) may:
  - Encourage migration of securitized assets into the non-bank financial system (shadow banking).
  - Lead to concentration of risk in other asset classes and amplify interconnectedness.
  - Reduce investor base for securitizations in regions (e.g., Europe) where insurers and banks face adverse treatment.
- Example: mortgage securitizations by Redwood Trust (a mortgage REIT) where a non-bank originator retained equity tranches—illustrates migration into non-bank issuance and potential need for risk-appropriate regulation and supervision of shadow-banking entities.

### Regulatory complexity, uncertainty, and policy considerations
- Industry cites regulatory complexity and uncertainty as key impediments to efficient securitization markets.
- Suggested considerations (from text discussion):
  - Regulators may want greater consistency in capital charges at the transaction level across approaches to reduce regulatory arbitrage.
  - Risk-appropriate regulation and supervision of non-bank originators and shadow-banking entities may be warranted.
  - U.S. context: the Collins Amendment imposes an SA-based floor, discouraging IRB approaches and implying SSFA may become the main method in the United States; non-U.S. offices/subsidiaries of U.S.-based banks must use the most conservative approach among BCBS proposals under the Dodd-Frank umbrella.
- Volcker Rule implications:
  - Inclusion of SPVs and ABCP conduits as “covered funds” could substantially increase legal and regulatory risk and origination costs due to strict compliance and recordkeeping, potentially increasing costs of securitization transactions.

*Source: IMF staff summary of Box 2, “Overview of the BCBS Proposals on Capital Charges.”*

### 1940. Hedge funds, private equity funds, enhanced cash funds, and many SPVs make use of these exemptions.

### _wp13255 - 1940. Hedge funds, private equity funds, enhanced cash funds, and many SPVs make use of these exemptions.

### Regulatory overlap, complexity, and effects on securitization markets
- Hedge funds, private equity funds, enhanced cash funds, and many SPVs make use of exemptions referenced in the source text.
- Regulated institutions can own up to three percent of the capital of covered funds, but must satisfy further restrictions; they are prohibited from providing loans, letters of credit, or guarantees to such funds.
- Overlapping regulatory measures increase legal and regulatory risk and costs, discouraging straightforward securitizations and single- and multi-seller ABCP conduits.
- U.S. regulatory developments:
  - The Dodd-Frank Act extends CFTC regulations under the Commodity Exchange Act (CEA) to essentially all entities that use OTC swaps, including securitization vehicles.
  - The CFTC rescinded the exemption from the CEA for highly sophisticated investors; SPVs will have to register with both the CFTC and the SEC, increasing compliance costs significantly.
  - In the second half of 2012, some securitization vehicles were exempt from the regulations applicable to commodity pools, but synthetic securitizations, CDOs, CLOs, ABCP conduits, and covered bonds continued to be subject to the new CFTC rules.
- Banking and insurance regulatory uncertainty:
  - Basel III market consultation concluded in mid-March 2013, but finalization and implementation likely to extend over a long period.
  - Finalization and implementation of Solvency II subject to repeated delays, with January 2016 given as the most recent target date.
- Dodd-Frank unresolved elements:
  - The final classification of the qualified residential mortgage (QRM) remains undecided; QRM will define mortgages that can be securitized without the 5 percent risk retention requirement imposed by Dodd-Frank on an RMBS issuer.
  - Market participants concerned QRM standards could be inconsistent with the European risk retention rule.

### Maturity measurement and capital implications (BCBS guidance)
- The BCBS (2012) lacks clear guidance on which approach to follow to define tranche maturity; time-tranching leads to very different expected maturities across tranches.
- One approach: compute expected maturity using the legal final maturity of underlying assets and apply to tranches according to the prospectus.
- Prepayment options (common in U.S. mortgages, credit cards, many corporate loans) complicate expected maturity estimation; BCBS (2012) is not clear on methodology in such cases.
- BCBS (2012) applies a minimum maturity of one year and a maximum of five years.
  - Applying a minimum maturity of one year may discourage banks from holding tranches with shorter residual lives due to higher minimum capital requirements under the proposal, despite such tranches generally having limited risk.

### Operational infrastructure deficiencies revealed in the crisis
- Servicers and trustees:
  - Servicers collect payments, transfer to trustees, and take remedial action (including foreclosure) on delinquent loans.
  - Trustees establish SPVs, administer them, and receive and distribute payments from servicers.
  - During the U.S. housing crisis, servicers and trustees were overwhelmed and insufficiently resourced, with business models calibrated to “normal times” of low defaults rather than periods of stress.
  - Allegations exist that conflicts of interest between owners of some servicers and investors led servicers to disregard investors’ interests (largest servicers owned by largest commercial banks with large second lien exposures).
- Mortgage Electronic Registration Systems, Inc. (MERS):
  - Established in 1995 to act as beneficial owner and title-holding entity, enabling transfers of mortgage notes without costly paperwork.
  - Resulted in instances where the registered owner of the mortgage did not match the economic owner of the mortgage note, leading to MERS-related lawsuits and cases where ownership could not be fully established.
  - Practice of initiating foreclosures in the name of MERS has since been discontinued.
  - Germany’s refinancing register (2005) and France’s legislation (1993) cited as examples of systems providing cost-efficient transfer of mortgages fully supported by legal frameworks.

### Credit rating agencies, bond insurers, and post-crisis rating practices
- Credit rating agencies (CRAs):
  - Post-2008 scrutiny and pressures appear to have pushed some CRAs to take excessively risk-averse approaches, modifying requirements for counterparties and cash depositories stringently and making securitizations more difficult and costly.
  - Specific CRA-driven constraints:
    - Sovereign-ratings caps on securitizations: securitization ratings are generally capped a few notches above that of the sovereign, problematic in the European periphery after multi-notch sovereign downgrades.
    - Minimum ratings of swap counterparties: e.g., derivatives counterparties rated by S&P cannot be rated more than four notches below the rating of the supported security if no collateral is posted; estimated impact of up to 25 bps per annum according to market participants.
    - Minimum ratings of cash depositaries tightened by CRAs for banks holding cash balances of securitization vehicles.
- Monoline bond insurers:
  - Private bond insurance was used to improve ratings of ABS and CDO tranches.
  - Monoline insurers were overwhelmed during the crisis and in many cases undercapitalized and unable to meet claims.
  - Largest monolines included Ambac Financial Group (AMBAC) and MBIA Insurance Corporation.

### Official sector intervention in ABS markets and market effects
- Asset purchase programs and quantitative easing:
  - Major central banks engaged in asset purchase programs to support housing markets; examples include ECB (Covered Bond Purchase Program), BoE (Asset Purchase Facility), Bank of Japan (Asset Purchase Program).
  - U.S. Federal Reserve purchases:
    - QE3 program of September 2012 included purchases of US$40 billion of agency MBS.
    - Monthly purchases of US$45 billion of treasury bonds were added in December 2012.
    - QE4 program described as conditionally open-ended.
  - Some central bank ABS purchases have been phased out; several direct U.S. intervention programs expired (e.g., AMLF and CPFF closed in February 2010; TALF closed for new CMBS loans in June 2010 and for other collateral in March 2010). TALF loans extended will mature by March 2015.
- Market concerns about price discovery:
  - Non-profit-maximizing asset purchases by the U.S. Federal Reserve may have distorted price discovery and crowded out private capital, impeding return of a healthy private-label MBS market.
  - Private-label MBS issuance in 2012 accounted for 0.7 percent of total MBS issuance, having averaged 17 percent throughout the 1990s.
- Discount window facilities and haircuts — inconsistent treatment of securitized assets:
  - United States:
    - 5–10 year duration covered bonds, in the AA to BBB range, and (jumbo) German Pfandbriefe and corporate bonds receive a 7 percent haircut; ABS with same duration and credit rating subject to a 14 percent haircut.
  - Euro area:
    - 0–1 year duration jumbo covered bonds, covered bank bonds, and conventional corporate debt, in the A to AAA rating category, subject to a 1 percent haircut; eligible ABS with same maturity and credit rating receive a 10 percent haircut.
  - United Kingdom:
    - 1–3 year duration covered bonds in the A-minus or above category subject to a 14 percent haircut; ABS backed by credit cards, student loans, consumer loans, and auto loans face a 17 percent charge; CMBS of similar rating and duration face a 27 percent haircut.
  - Reduced use of securitizations at central bank discount windows:
    - Share of ABS in total repo activity within the ECB declined from 28 percent in 2008 to 16 percent in 2012.
    - In the two years to end-2012, the volume of ABS used in repos with the ECB declined 21 percent in absolute terms, while the use of covered bonds as collateral increased 72 percent.
  - ECB actions:
    - Following review, ECB announced initial steps to level playing field between securities with comparable risks, including reduction in haircuts for ABS eligible under permanent and temporary Eurosystem collateral framework (example: from 16 to 10 percent) and tightening risk control measures for retained covered bonds.

### Policy recommendations (overview)
- The paper presents a broad suite of 29 policy recommendations—or “core principles”:
  - 16 recommendations in Section A aimed at addressing factors that contributed to the crisis and mitigating the risk of another adverse self-reinforcing cycle.
  - 13 recommendations in Section B aimed at addressing obstacles to the resumption of a robust securitization market.
- Examples from the recommendations (preserving source wording and focus):
  - 1. Measures to improve the quality of underlying loan origination practices are to be encouraged; risk-based frameworks defining regulatory provisions and capital could provide incentives that reinforce solid origination practices.
  - 2. The establishment of the Consumer Financial Protection Bureau (CFPB) with comprehensive powers to regulate and supervise is welcomed, particularly as it can bring certain nonbanks under its supervision when their activities pose risks to consumers.

*Italic: Content derived from _wp13255 - 1940. Hedge funds, private equity funds, enhanced cash funds, and many SPVs make use of these exemptions.*

### 3. The definition of QM in the United States is a welcome regulatory initiative that directly

### _wp13255 - 3. The definition of QM in the United States is a welcome regulatory initiative that directly

### Qualified Mortgage (QM) definition and appraisal integrity
- QM aims to protect consumers from being sold inappropriate loans or assuming debt burdens that are unlikely to be serviceable.
- Ineligible loan types for QM designation include balloon, negative amortization, exotic loan products.
- QM includes explicit limits on credit metrics (such as debt-to-income ratios) to help ensure satisfactory loan performance.
- Provisions in the Dodd-Frank Act to enhance supervision of the home appraisal process are recommended for consideration in other jurisdictions:
  - Loan officers (rather than mortgage brokers) should select appraisers.
  - Maintain records on appraiser performance via a property value registry with a focus on identifying consistently inflated valuations.

### Prudential policies and collateral treatment
- Collateral accepted for additional borrowing should emphasize cash and income relative to unrealized capital gains in asset prices.
- Larger haircuts should apply to collateral based on unrealized asset price gains because of higher volatility of asset prices vis-à-vis cash and income.

### Securitization origination and "skin in the game"
- Retention of some originator risk (skin in the game) can help align incentives but is not a panacea; focus should be on incentives across the securitization chain.
- European experience shows banks retaining virtually all underlying risk were not insulated from significant turmoil (example: Spain).
- Clearly and consistently enforced repurchase (RW) clauses can ensure skin in the game; RW clauses and similar measures by Fannie Mae and Freddie Mac improve clarity around loan put-back terms.
- Regulators should ensure investors in synthetic and highly complex structured products are highly sophisticated and able to absorb possible losses, particularly if they are banks or systemically important entities.
- Historical evidence: securitization markets over 1970–99 based on good collateral, simplicity, and transparency can withstand significant adverse events.

### Credit rating agencies (CRAs): role, incentives, and transparency
- Regulators should de-emphasize the role of conventional credit ratings; removal of statutory references to CRA ratings in the EU (EU Regulation on CRAs) and the United States (Dodd-Frank Act) are welcomed.
- The issuer-pays model has inherent conflicts of interest; no clear alternatives currently address the full range of associated issues (e.g., enforced rotation of CRAs).
- Recommended transparency and compliance measures:
  - Publish revenue shares for each rated entity in buckets (e.g. below 0.5 percent, 0.5–2 percent, 2–5 percent, and above).
  - Separate analysts and sales departments; isolate analysts from revenue decisions and sales relationships.
  - Publish ratings processes and remuneration schedules of employees involved in ratings.
  - Encourage data vendors to disseminate this information.
  - Requirement for issuers or related third parties to engage at least two different CRAs for structured finance instruments is welcomed.
- Improve disclosure practices for securitized asset ratings:
  - (i) Transparency in CRA models and assumptions.
  - (ii) Clear disclosure of methodological differences between ratings for conventional fixed-income securities and securitizations.
  - (iii) Encourage publication of all non-confidential information underlying ratings, including stress test results where applicable.
- Require ongoing disclosure of all loan-relevant data by loan originators and securitization arrangers.
- Full transparency over ratings and quality control: disclose numbers of rejected loans, nature of material deficiencies, and make historical loan performance data for originators and issuers freely available.
- Issuers should declare why a particular CRA was chosen and inform investors of preliminary CRA assessments, especially unfavorable ones, to reduce “ratings shopping.”
- Examine PCS (prime collateral securities) labeling initiative in Europe, which standardizes securitization characteristics and provides capital relief for banks holding high-quality securitized assets; further analysis needed on cost/benefit relative to CRA approach and potential unequal treatment of similar-risk securities.

### Investors, reporting, and reliance on ratings
- Strive for homogenous reporting standards for SIVs and related entities, with focus on disclosure of funding and credit risks and standardized reporting of contingent funding exposure across firms.
- SIVs, conduits, sponsors, and asset managers should fully disclose business and other relevant relationships between equity holders, founders, and sponsors.
- Encourage investors to reduce reliance on credit ratings by:
  - Revising investment mandates to de-emphasize credit ratings as the primary inclusion criterion.
  - Eliminating forced selling of securities upon credit downgrade.
  - Following IOSCO and FSB recommendations to give investors means to make informed decisions based on issuer disclosure, e.g., comprehensive data sets of structure and underlying risks.
  - Requiring market participants to have access to detailed loan-by-loan data for securitization transactions.

### Addressing impediments to a healthy securitization market — regulatory initiatives
- Where RRBA still applies, continue to mitigate counterproductive incentives, especially where credit ratings incentivize leveraged structures and cliff effects.
- Complexity and uncertainty in new U.S. and European regulatory measures hinder securitization market resumption:
  - U.S. authorities should consider exempting standard securitization vehicles from the covered fund designation under the Volcker Rule to avoid classification alongside hedge funds and private equity.
  - The CFTC should consider reinstating all or part of the CEA exemptions for highly sophisticated investors and reconsider exemptions from commodity pool regulations for non-synthetic securitizations, particularly single- and multiseller ABCP conduits.
- Focus on consistency of capital charges across different regulatory computational approaches to reduce regulatory arbitrage and level playing field across jurisdictions.
- Establish more symmetric treatment of securitization exposures and covered bonds with similar risk characteristics across capital and liquidity regulations and Solvency II to avoid regulatory arbitrage and undue concentration of risk.
- Regulatory reforms should proceed swiftly to eliminate uncertainty; Solvency II capital requirement rules and formal instatement of the QRM rule are essential for restoring support for securitized assets.
- Clarify definition of tranche “maturity” under BCBS (2012) proposals to avoid regulatory arbitrage and inappropriate exclusion of low-risk investments:
  - Regulators could derive tranche maturities using conservative assumptions on defaults and prepayments via industry-standard models or the BCBS could develop its own cash-flow modeling approach.

### Operational infrastructure and market impediments
- Strengthen legal foundation for a modern electronic mortgage registration system in the United States (and other appropriate jurisdictions) to minimize legal ambiguities and litigation costs.
- CRA practices on derivatives counterparty ratings, sovereign rating caps, and depository ratings impede securitization; additional CRA transparency on how these elements influence transaction ratings would be helpful.
- Sovereign rating caps in parts of the euro area keep transaction ratings below what they otherwise would be; a limited pan-European guarantee scheme covering only sovereign risk elements affecting transactions (essentially currency redenomination risk) could be useful:
  - Such a scheme could be general or targeted (e.g., SME securitizations) and could be provided through the European Investment Bank or another pan-European agency.

### Official sector intervention and central bank treatment
- Ongoing evaluation of costs and benefits of global central bank intervention in asset-backed and mortgage securities markets is needed, particularly where interventions impede the private sector and distort price discovery.
- Governments should carefully weigh public involvement in the mortgage market against potential to impede price discovery and contribute to financial instability (excess credit accumulation, asset bubbles, contingent liabilities).
- Central banks should re-examine severe discount-window treatment of securitized assets vis-à-vis similar-risk assets; ECB Governing Council steps to level the playing field between comparable securities are welcomed and may guide other major central banks.

### Box 3 — Securitization and complementary policy measures to ease credit conditions for SMEs in Europe
- Securitization can free up bank balance sheets for new lending or reduce bank funding costs and/or capital charges; a healthy primary and secondary market for SME loan securitization could be feasible because:
  - SME loans have relatively short amortization schedules.
  - National government SME loan guarantee funds have improved data collection and processing standards in some countries (e.g., Spain).
  - SMEs rely on bank financing and thus have strong incentives to avoid default.
  - Large, diversified SME loan portfolios reduce concentration risk for investors.
- Two ways to encourage a healthy secondary SME securitization market:
  1. Address asymmetric treatment of securitized assets vis-à-vis other assets with similar risk characteristics (see Section III. A. “Asymmetric capital charges”).
  2. Introduce a double-tier guarantee scheme for SME securitizations:
     - First layer: national governments provide credit risk protection.
     - Second layer: guarantees sovereign risk.
     - Aims: remove binding sovereign rating caps and provide credit enhancement to attract ratings-constrained investors; could be provided through the European Investment Bank or another pan-European agency.
- Establish asset management companies (AMCs) to address non-performing non-real estate–related assets:
  - Broaden scope of established AMCs or create AMCs focused on non-real estate assets to leverage specialist private sector capital (distressed debt investors) focused on recovery values of non-performing assets.

*Source: _wp13255*

### 4. Regulation and standardization of information for proper risk evaluation. Which could

### 4. Regulation and standardization of information for proper risk evaluation. Which could positively impact loan origination, and therefore securitizations and the full self-reinforcing credit intermediation channel (as depicted in Figure 6).

### Summary of recommendations and status (select highlights)
- Comprehensive supervision from loan origination to eventual securitization and capital provisioning.
  - Reference: Dodd-Frank Act (USA).
  - Status: Enabled since January 2013.
- Consumer protection and compensation practices
  - Improve consumer protection with respect to predatory lending.
  - Reference: Dodd-Frank Act (USA) • Qualified Mortgage.
  - Status: Qualified Mortgage instituted by CFPB in January 2013; in force as of January 1, 2014.
- Appraisal process
  - Enhanced supervision of the home appraisal process; maintenance of records on appraiser performance.
  - Reference: Dodd-Frank Act (USA).
  - Status: Enabled since January 2013.
- Credit metrics and macroprudential policy
  - Binding limits on credit metrics/serviceability (especially of second mortgages).
  - Counter-cyclical macroprudential policies to de-emphasize unrealized capital gains as collateral for new borrowing in asset price upswings.
  - Reference: Dodd-Frank Act (USA) • Qualified Mortgage • Ability-to-Repay (ATR) rule; IMF staff.
  - Status: Qualified Mortgage and ATR rule instituted by CFPB in January 2013; in force as of January 1, 2014. Proposal (IMF staff).
- “Skin in the game” and securitization-chain incentives
  - “Skin in the game” retention rules may align incentives but are not a panacea; regulatory attention should be focused on incentives across the entire securitization chain.
  - Reference: IMF staff; Dodd-Frank Act (USA); implementation of CRD IV (EU) in progress.
  - Status: Proposal; Dodd-Frank Act enabled since January 2013.

### Financial engineering, product complexity, and quality controls
- Promote simple, generic, and standardized financing vehicles over esoteric, synthetic, and speculative investment structures.
  - Investments in synthetic and highly complex structured products to be held to higher regulatory and capital standards than simple structures.
  - Conservative capital requirements for loans of lower quality.
  - References: BSBC; IMF staff.
  - Status: Proposal.
- Representations and warranties (RWs) and quality control firms
  - Clearly formulated RWs with a strong legal foundation as another form of “skin in the game.”
  - Reference: IMF staff.
  - Status: Proposal.

### Credit rating agencies (CRAs): misaligned incentives and disclosure
- De-emphasize statutory references to credit ratings and discourage excessive reliance by market participants on credit ratings.
  - References: FSB, Dodd-Frank Act (USA), EU Regulation on Credit Rating Agencies.
  - Status: Partially enacted; in progress.
- CRA business-model accountability
  - CRAs operating “issuer-pays” to be held more accountable where systematic and large divergences exist between ratings-implied default probabilities and realized defaults.
  - Reference: EU Regulation on Credit Rating Agencies, Dodd-Frank Act (USA).
  - Status: Partially enacted; in progress.
- Transparency and separation
  - Improve transparency of commercial interconnectedness between issuers and CRAs; separate analysts from sales departments; engage two different CRAs for structured finance instruments.
  - Reference: IMF staff; EU Regulation on Credit Rating Agencies.
  - Status: Proposal; partially enacted; in progress.
- Methodologies and disclosure
  - Improved disclosure of model and assumptions underlying ratings of securitizations, differences in methodologies relative to conventional fixed-income securities, and results of stress tests and sensitivity analysis.
  - References: BoE, ECB, SEC (authorized by Dodd-Frank Act), EU Regulation on Credit Rating Agencies, IMF staff.
  - Status: Enacted; proposal.
  - Ongoing and timely disclosure of underlying loan-level data between quality control firms/CRAs and investors.
  - References: BoE, ECB, SEC (authorized by Dodd-Frank Act).
  - Status: Enacted.
- Ratings-shopping and concentration issues
  - Improved disclosure of “ratings shopping” by issuers; disclose ratings derived from specific issuers in ranges.
  - Reference: IMF staff.
  - Status: Proposal.

### Investors, reporting, and transparency
- Homogenous reporting standards for SIVs and related entities encouraged, with focus on disclosure of associated funding and credit risks by funding-line providers and full transparency regarding business and other relationships between equity holders, founders, and sponsors.
  - Reference: IMF staff.
  - Status: Proposal.
- Investors to reduce mechanistic reliance on credit ratings and to have access to timely/detailed loan-by-loan data for securitizations.
  - References: FSB, EU Regulation on Credit Rating Agencies, IOSCO, IMF staff.
  - Status: In progress; partially enacted.

### Regulatory impediments, capital treatment, and regulatory arbitrage
- Capital charges and regulatory formulae
  - Conduct further analysis of proposed capital charges on securitizations; focus efforts on consistency of capital charges across different regulatory computational approaches.
  - Reference: IMF staff.
  - Status: Proposal.
- Symmetric treatment relative to covered bonds
  - Establish a more symmetric treatment of securitization exposures and covered bonds across relevant regulatory frameworks to avoid unintended consequences and regulatory arbitrage.
  - Examples cited: Capital Requirements Directive IV for banks and Solvency II for insurers; liquidity coverage ratio (LCR); Net stable funding ratio (NSFR).
  - Reference: IMF staff.
  - Status: Proposal (implementation of Basel III until 2018; Solvency II (delayed at least until January 2016); initial introduction of the LCR in 2015; introduction of the NSFR in 2018).
- Volcker Rule and commodity pool regulations
  - Reconsideration of the “covered fund” designation under the U.S. Volcker rule is encouraged (exempt plain vanilla securitization vehicles).
  - CFTC to consider exemptions from the commodity pool regulations for non-synthetic securitizations.
  - Reference: IMF staff.
  - Status: Proposal.

### Regulatory uncertainty and operational infrastructure
- Regulatory rulemaking speed
  - Regulatory reforms should proceed as swiftly as reasonably possible to eliminate regulatory uncertainty; issuance of Basel capital and other rules, rulemaking related to the Volcker rule, and the definition of the QRM should be issued as soon as possible.
  - Reference: IMF staff.
  - Status: Proposal.
- Tranche maturity definition
  - The definition of tranche “maturity” for purposes of risk-weight calculation under the BCBS (2012) should be clarified; regulators should test simple models often-used by market participants based on conservative assumptions.
  - Reference: IMF staff.
  - Status: Proposal.
- Mortgage market infrastructure
  - Minimize legal ambiguities and associated uncertainties and litigation costs with a strong legal foundation for modern electronic mortgage and loan registration systems (e.g., addressing weaknesses such as Mortgage Electronic Registration Systems, Inc. (MERS)).
  - Reference: IMF staff.
  - Status: Proposal.
- CRA sovereign rating caps and government support
  - Require CRAs to disclose details of the impact of derivatives counterparty ratings, sovereign rating caps, and depository ratings on the overall credit rating of securitizations.
  - Consider government insurance schemes for securitizations (or tranches thereof) and pan-government insurance schemes where economic uncertainty and sovereign rating caps may be exacerbating tight credit conditions in one country (preferably in a countercyclical fashion).
  - Reference: IMF staff.
  - Status: Proposal.

### Official sector intervention in ABS markets and central bank operations
- Asset purchase programs and loan programs
  - The costs and benefits associated with asset purchase and loan programs by global central banks need to be evaluated on an ongoing basis, particularly where these actions distort price discovery or lead to build-up of additional risks.
  - Policymakers should carefully examine costs and benefits associated with various forms of sustained public involvement in the mortgage market (designed to increase availability and decrease cost of credit).
  - Reference: IMF staff.
  - Status: Proposal.
- Discount window facilities and haircuts
  - Central banks to revisit whether the relatively severe treatment of securitized assets (vis-à-vis assets with similar risk characteristics) at the discount window can be justified.
  - Reference: IMF staff.
  - Status: Proposal; some measures enacted by ECB in July 2013.

### Appendix I — Securitization: the first 30 years (1970–1999) — key developments
- Industry origins and GSEs
  - The securitization industry was born in 1970 following the first pass-through security sponsored by the Government National Mortgage Association (GNMA, or “Ginnie Mae”).
  - FHLMC (“Freddie Mac”) began securitizing U.S. residential home mortgages in 1971.
  - FNMA (“Fannie Mae”) began securitizing in 1981; Fannie Mae was founded in 1938 and privatized in 1968.
- Private-label and asset-class evolution
  - First private-label mortgage pass-through deal issued by Bank of America in 1977.
  - First private-label ABS deal issued by Sperry Univac Corporation in 1985.
  - Until the 1986 U.S. tax act, tranching of RMBS deals was uneconomical.
  - Auto-related securitizations dominated early ABS; credit card receivables first issued in 1987 and grew rapidly thereafter.
- Geographic diffusion and scale
  - United States preceded the United Kingdom by 15 years and continental Europe by 20 years.
  - United Kingdom’s first mortgage securitization launched in 1985.
  - France laid legal foundation in 1988; first RMBS transaction in 1991.
  - In the Dutch case ABS amounted to almost €270 billion at end-2007, or 50 percent of Dutch GDP (almost two-thirds of which were comprised of RMBS; Chaudron, 2008).
  - Germany’s KfW issued €125 billion of RMBS and SME securitizations between 2000 and 2008.
- Product innovation timeline
  - Subprime securitizations became a regular fixture in the early 1990s.
  - Issuance of collateralized debt obligations (CDOs) commenced in the late 1990s.
  - Credit default swaps (CDSs) developed for corporate debt in the 1990s and first adopted to ABS in the late 1990s.

### Appendix II — The basics of securitization — overview of mechanics and participants
- Mechanics (participants listed)
  - Originator(s) (of collateral assets)
  - Arranger (of securitization transaction)
  - Securitization Vehicle (SPV — bankruptcy-remote)
  - Investor(s) (in securities)
  - Other participants: Credit rating agencies; Quality control firms; Servicer; Trustee; Lawyers; Guarantor; Asset manager; Custodian
- Origination and asset pools
  - Collateral assets typically securities, loans, lease payments, expected fee or royalty income, or credit card receivables.
  - Securitization provides balance sheet and capital relief to originators and allows them to originate new loans.
  - Asset pools may be seasoned loans or newly originated loans; some structures include revolving periods or asset substitution provisions; CDOs/CLOs may appoint asset managers who actively manage part of the pool.
- Structuring and issuing securities
  - Principal structuring techniques: credit-tranching and time-tranching.
  - Credit-tranching creates senior/super-senior tranches with priority claims and lower-rated mezzanine and equity tranches that absorb losses.
  - Time-tranching sequences payments by expected maturities; early examples include CMOs introduced by the GSEs and Ginnie Mae.
  - Other credit enhancements: overcollateralization, financial guarantees, and use of derivatives (interest rate or currency swaps) to hedge risks.

*Italicized source: IMF staff, “4. Regulation and standardization of information for proper risk evaluation. Which could” (PDF chapter content provided).*

### APPENDIX III. MAIN FEATURES OF THE U.S. AND CONTINENTAL EUROPEAN

### APPENDIX III. MAIN FEATURES OF THE U.S. AND CONTINENTAL EUROPEAN MORTGAGE SECURITIZATION MARKETS

### Role of government-sponsored entities (GSEs) and government guarantees
- The two GSEs, Fannie Mae and Freddie Mac, along with Ginnie Mae, dominate the U.S. mortgage market.
- Ginnie Mae securities have an explicit U.S. federal government guarantee.
- Securities backed by GSE-guaranteed collateral were generally considered by investors to be implicitly guaranteed by the U.S. government.
- When Fannie Mae and Freddie Mac were taken over by the U.S. government in September 2008, their obligations moved a step closer to becoming outright obligations of the government.
- The Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs, and the Farmers Home Administration (until 1994) insure mortgages issued under the Ginnie Mae label.
- The two GSEs buy so-called conforming mortgages from loan originators; conforming mortgages must be below a certain size (currently US$417,000 with some regional variations) and fulfill a number of quality requirements.
- Remaining mortgages that cannot be insured by a government agency or bought by the GSEs are retained by the originating institution, sold to another investor, or securitized with the help of an arranger.
- The U.S. was the first economy to emerge with a liquid securitization market, kickstarted by Ginnie Mae and the GSEs.

### Originate-to-Distribute Model and differences between U.S. and continental Europe
- The Originate-to-Distribute Model consists of originating loans for resale via securitization; it marked a key difference between U.S. and European securitization markets.
- By the mid-2000s, most mortgages in the United States were originated by mortgage brokers or nonbanks (including internet origination).
  - Sixty-eight percent of all U.S. mortgage loans were originated by brokers in 2004.
  - 72 percent of all subprime loans in the second half of 2006 were originated by brokers (Highbeam, 2013).
- In continental Europe, securitization of residential mortgages on a large scale did not take place, with the exception of Spain and the Netherlands.
  - Dutch RMBS were issued mainly for funding purposes, not for purposes of risk transfer.
- The PROVIDE program of Germany’s development bank, KfW, removed some mortgage-related risks from the balance sheets of German banks, as well as from banks based in the United Kingdom, the Netherlands, and other European countries.
- An Originate-to-Distribute culture never took hold in Europe; loan origination stayed principally within the banking system.

### Development of ABS-CDO markets and cross-border exposures
- The issuance of arbitrage ABS-CDOs was largely a U.S. phenomenon.
  - These securities tended to have (mostly subprime) ABS as collateral or were structured as synthetic CDOs using CDS on ABS tranches.
  - CDOs made up the second largest sector of the U.S. ABS market after subprime bonds in 2006, at US$315 billion (of which 54 percent were ABS-CDOs).
  - Cash ABS-CDO volumes reached US$109 billion by 2006.
  - Synthetic CDOs expanded from US$14 billion to US$54 billion in 2006, an increase of 276 percent.
- Issuance of arbitrage CDOs was essentially nonexistent in Europe, largely due to the lack of appropriate high-spread collateral.
- Numerous European banks invested in U.S. securitized products, including CDOs, frequently via structured investment vehicles (SIVs) established in Ireland.
  - Many of these SIVs were later bailed out by their parents, including SIVs managed by IKB, Sachsenbank, HSH Nordbank, and West LB.

### Distinct legal, tax, and accounting frameworks (Germany as a case study)
- Legal, tax, and accounting differences led to divergent development of continental European securitization markets relative to the United States.
- Germany timeline and reforms:
  - 1997: German banking regulator allowed banks to securitize assets by defining requirements for the sale and securitization of loans to meet regulatory capital relief calls.
  - 2002: Accounting requirements for true-sale securitizations were outlined.
  - 2004: A number of German tax laws that impeded securitizations were removed.
  - 2005: Introduction of the Refinancing Register, automating the process of transferring mortgages and allowing an SPV to be the sole legal owner of a mortgage if the transfer of title to the house serving as collateral was registered with the mortgage servicing company (usually the originating bank).
- KfW’s PROVIDE transactions circumvented taxation-related impediments by housing the SPVs underlying its mortgage securitizations in Ireland.
- Many changes to relevant laws in Europe were instituted only a short time before the GFC, preventing the European market from having sufficient time to mature and grow to a size comparable to that of the United States.

*Source: _wp13255 - APPENDIX III. MAIN FEATURES OF THE U.S. AND CONTINENTAL EUROPEAN MORTGAGE SECURITIZATION MARKETS*

### REFERENCES

### _wp13255 - REFERENCES

### International organizations, central banks, and standard-setting bodies
- Bank for International Settlements, 2004, International Convergence of Capital Measurement and Capital Standards (Basel).
- Bank for International Settlements, 2011, Securitization is Not That Evil After All, No.341 (Basel).
- Basel Committee on Banking Supervision, 2006, "International Convergence of Capital Measurement and Capital Standards - A Revised Framework - Comprehensive Version" (Basel).
- Basel Committee on Banking Supervision, 2010, “International framework for liquidity risk and monitoring tools” (Basel), December.
- Basel Committee on Banking Supervision, 2012, “Revisions to the Basel Securitisation Framework,” Consultative Document (Basel).
- Basel Committee on Banking Supervision, 2013, “Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools” (Basel).
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- Financial Stability Board, 2010, “Principles for Reducing Reliance on CRA Ratings,” (Basel).
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### IMF and related policy-focused reports and speeches
- Bernanke, Ben, 2005, “The Global Savings Glut and the U.S. Current Account Deficit,” Sandridge Lecture, Virginia Association of Economists, Richmond, Virginia, March 10.
- Bernanke, Ben, 2008, “Fostering Sustainable Homeownership,” National Community Reinvestment Coalition Annual Meeting, Washington, D.C., March.
- Carney, Mark, 2012, “Some Current Issues in Financial Reform,” Speech to the Canadian Club of Montréal, Montréal, Quebec, November.
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- Stein, Jeremy, 2013, “Overheating in Credit Markets: Origins, Measurement, and Policy Responses,” remarks at “Restoring Household Financial Stability after the Great Recession: Why Household Balance Sheets Matter.” A Research Symposium sponsored by the Federal Reserve Bank of St. Louis, St. Louis, Missouri, February.
- International Monetary Fund, 2009, “Restarting Securitization Markets: Policy Proposals and Pitfalls” Chapter 2 in Global Financial Stability Report, World Economic and Financial Surveys (Washington).
- International Monetary Fund, 2012, “The Reform Agenda: An Interim Report on Progress Toward a Safer Financial System,” Chapter 3, Global Financial Stability Report, World Economic and Financial Surveys (Washington).

### Academic articles, working papers, and economic history
- Benmelech, Efraim; Jennifer Dlugosz, and Victoria Ivashina, 2012, “Securitization Without Adverse Selection: The Case of CLOs,” Journal of Financial Economics, Vol. 106, Issue 1, October.
- Bordo, Michael, 1986, “Some Historical Evidence 1870-1933 on the Impact and International Transmission of Financial Crises,” NBER Working Paper 1606.
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- Kindleberger, Charles, 1978, Manias, Panics, and Crashes: A History of Financial Crises, (New York: Basic Books).
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- Rajan, Raghuram, 2005, "Has financial development made the world riskier?" Proceedings, Federal Reserve Bank of Kansas City, Aug. Issue, pp. 313–369.
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- Stein, Jeremy, 2013, “Overheating in Credit Markets: Origins, Measurement, and Policy Responses,” remarks at “Restoring Household Financial Stability after the Great Recession: Why Household Balance Sheets Matter.” A Research Symposium sponsored by the Federal Reserve Bank of St. Louis, St. Louis, Missouri, February.
- Duffie, Darrell, 2007, “Innovations in Credit Risk Transfer: Implications for Financial Stability,” Working Paper (Stanford University, Graduate School of Business).
- Brunnermeier, Markus, 2009, “Deciphering the Liquidity and Credit Crunch of2007 –2008,” Journal of Economic Perspectives, Vol. 23, Issue 1, pp. 77–100.
- Bordo, Michael, 1986, “Some Historical Evidence 1870-1933 on the Impact and International Transmission of Financial Crises,” NBER Working Paper 1606.

### Industry reports, bank and rating agency publications, and white papers
- Association for Financial Markets in Europe, 2013, Securitisation Data Report Q3:2012 (London).
- Association for Financial Markets in Europe, 2012, The Economic Benefits of High Quality Securitization to the EU Economy (London).
- Barclays Bank PLC, 2013, The AAA Handbook 2013 (London).
- Credit Suisse, 2013, “Response to the Consultative Paper on Revisions to the Basel Securitization Framework,” (Zurich).
- Fitch Ratings, 2013, “Spanish Covered Bonds Not Affected by Residual Claims,” April 8. Available via the Internet: www.fitchratings.com/gws/en/fitchwire/fitchwirearticle/ Spanish-Covered-Bonds?pr_id=787704.
- Global Financial Markets Association, 2013, “GFMA Response to the Consultative Document on Revisions to the Basel Securitization Framework,” March 18.
- Gordian Knot, 2013, “A Return-Allocated Capital-Equivalence Approach for Securitisations,” Bank for International Settlements (Basel).
- Moody’s, 2012a, “Default & Loss Rates of Structured Finance Securities: 1993-2011,” Special Report (New York).
- Moody’s,2012 b, “CLOs and the Simplified Supervisory Formula Approach (SSFA),” Research/White Paper (New York).
- Principal Collateral Securities Secretariat, 2013, “Europe in Transition: Bridging the Funding Gap,” Working Paper, March.
- International Financing Review, 2012, “Covered Bond Roundtable 2012,” Thomson Reuters (June). Available via the Internet: http://edition.pagesuite-professional.co.uk/ Launch.aspx?EID=858b8dee-8fb7-4048-88c6-a3c156c40a1a
- International Organization of Securities Commissions, 2012, Global Developments in Securitisation Regulation, Final Report (Madrid).
- MarketWatch, 2007, “Citigroup says it will absorb SIV assets,” December 13. Available via the Internet: www.marketwatch.com/story/citi-plans-to-absorb-49-billion-in-siv-assets-onto-balance-sheet.
- Highbeam, 2013, “Loan Brokers,” Industry report, Highbeam Business Report, The Gale Group, Inc. Available via the Internet: business.highbeam.com/industry-reports/finance/loan-brokers.

### Legal, regulatory, and government documents
- Credit Rating Agency Reform Act, 2006. Available via the Internet: www.govtrack.us/ congress/bills/109/s3850.
- Day Pitney, 2010, “Treatment of Trust Preferred Securities Under Dodd-Frank,” (Washington, D.C.), July.
- Council on Foreign Relations, 2013, “The Credit Rating Controversy,” updated February 2013.
- United States, Securities and Exchange Commission, 2012, Annual Report on Nationally Recognized Statistical Rating Organizations (Washington).
- United States, Securities and Exchange Commission , Department of the Treasury, and Office of Federal Housing Enterprise Oversight, 2003, A Staff Report of the Task Force on Mortgage-Backed Securities Disclosure (Washington).
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- United States of America, Federal Bureau of Investigation, 2004, Financial Institution Fraud and Failure Report (Washington). Available via the Internet: www.fbi.gov/stats- services/publications/fiff_04.
- United States of America, Federal Deposit Insurance Corporation, 2006, “Challenges and FDIC Efforts Related to Predatory Lending,” Audit Report (Washington: Office of Inspector General).
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- Westlaw, 2013, “State Of North Carolina, ex rel. Roy Cooper, Attorney General, Plaintiff, v. The McGraw-Hill Companies, Inc. and Standard & Poor's Financial Services LLC, Defendants,” Superior Court of North Carolina, Superior Court Division, (Wake County), February 5.
- Sweet, Charles A., and William R.B. Springer, 2012a, “CFTC Issues Broader Interpretive Exclusion From Commodity Pool Regulation for Certain Securitizations, and Temporary Registration Relief for Securitizations and Other Swap-Based Commodity Pools,” Bingham.com, Legal Alerts, October. Available via the Internet: www.bingham.com/Alerts/2012/10/CFTC-Issues-Exclusion-from-Commodity-Pool- Regulation.
- Sweet, Charles A.; Joshua B. Sterling; and William R. B. Springer, 2012b, “CFTC Issues Broader Interpretive Exclusion From Commodity Pool Regulation for Securitizations, and No- Action Advice ‘Grandfathering’ Some Securitizations and Extending Temporary Registration Relief Until March 31, 2013,” Bingham.com, Legal Alerts, December. Available via the Internet: www.bingham.com/Alerts/2012/12/CFTC-Issues-Broader- Interpretive-Exclusion-From-Commodity-Pool-Regulation-for-Securitizations.
- Cadwalader, 2012, “Impact of the Volcker Rule on Markets and Market Participants.”
- Cohan, William, 2012, "How We Got the Crash Wrong," The Atlantic, June.
- Coker, Don, 2012, “Repurchase & Buyback Demands, Representations and Warranties Claims in Residential Mortgage-Backed Securities.”Available via the Internet: www.hgexperts.com/article.asp?id=24951.
- State Street, 2009, “State Street Announces Common Stock Offering,” Press Releases, May 15 (Boston). Available via the Internet: pr.statestreet.com/us/en/ 20090518_1.html

### Country-specific and institutional studies, legal analyses, and working papers
- Germany, Kreditanstalt für Wiederaufbau, undated, “SME securitization by KfW—a decade in review” (Frankfurt).
- Kaiser, Bernhard, and Stuart Axford, 2006, “Principal Legal Issues of German True Sale Securitization,” Chapter 23 in Securitizations: Legal and Regulatory Issues/With Update, ed. by Patrick D. Dolan and C. van Leer Davis.
- Kofner, 2009, “The German Pfandbrief system facing the financial crisis,” Institute for Transformation, Housing and Social Spatial Development, International Housing Conference, June 28–July 1.
- Krauss, Stefan, 2005, “Synthetic Securitization Platforms Established by KfW,” in Securitizations of Derivatives and Alternative Asset Classes: Yearbook 2005, ed. by Jan Jod de Vries Robbé and Paul Augustine Usman Ali.
- Siewert, Jan B., and Vonhoff, Volker, 2011, “Liquidity and Credit Risk Premia in the Pfandbriefe Market,” January 15.
- Thompson, Anthony, Elen Callahan, Conor O’Toole, and Ganesh Rajendra, 2007, “Global CDO Market: Overview and Outlook,” Deutsche Bank (Frankfurt).
- Bronzwaer, Max, 2012, “Dutch RMBS,” The Journal of Structured Finance, Vol. 17, No. 4 (winter), pp. 134-137.
- Kothari, Vinod, 2006, Securitization. The Financial Instrument of the Future (Singapore: John Wiley & Sons (Asia) Pte Ltd).
- Kothari, Vinod, 2008, “The Name is Bond. Covered Bond.” Working Paper.
- Shivdasani, A., Yihui Wang, 2011, “Did Structured Credit Fuel the LBO Boom?” The Journal of Finance, Vol. 66, Issue 4 (August), pp. 1291–1328.
- Siewert, Jan B., and Vonhoff, Volker, 2011, “Liquidity and Credit Risk Premia in the Pfandbriefe Market,” January 15.
- Thomas, (entry repeated if present in source should be preserved) [Note: original source contains repeated and closely related entries; all preserved above as in source.]

### Books, commentary, and journalistic pieces
- Blinder, Alan, 2009, "Six Errors on the Path to the Financial Crisis," The New York Times, January 24. Available via the Internet: www.nytimes.com/2009/01/25/business/ economy/25view.html?_r=0.
- Cohan, William, 2012, "How We Got the Crash Wrong," The Atlantic, June.
- Muolo, Paul, and Mathew Padilla, 2008, Chain of Blame (Hoboken, NJ: John Wiley & Sons, Inc.).
- New York Times, 2013, “Accuracy of Appraisals Is Spotty, Study Says,” May 8.
- Martin, David, and Matthew Franker, 2011, “Rating Agency Regulation after the Dodd-Frank Act: A Mid-Course Review,” Insights, December.
- Stiglitz, Joseph E., 2009, “Capitalist Fools,” Vanity Fair (January).
- Stewart III, G. Bennett, 2003, “Pension Roulette: Have You Bet Too Much on Equities?” Harvard Business Review (June). Available via the Internet: http://hbr.org/2003/06/pension-roulette-have-you-bet-too-much-on-equities/ar/1.
- Muolo, Paul, and Mathew Padilla, 2008, Chain of Blame (Hoboken, NJ: John Wiley & Sons, Inc.).
- Kothari, Vinod, 2006, Securitization. The Financial Instrument of the Future (Singapore: John Wiley & Sons (Asia) Pte Ltd).

### Legal and regulatory commentary, market practice notes, and consultation responses
- Cadwalader, 2012, “Impact of the Volcker Rule on Markets and Market Participants.”
- Eavis, Peter, 2012, “Can Securitization Live With Volcker?" New York Times Dealbook (New York: New York Times).
- Herring, Richard J., 2009, “Policy Issues Concerning the Reform of the Credit Rating Agencies,” Pew Financial Reform Project, Briefing Paper #14.
- OECD, 2010, “Competition and Credit Rating Agencies,” Hearing, Competition Committee (Paris).
- Principal Collateral Securities Secretariat, 2013, “Europe in Transition: Bridging the Funding Gap,” Working Paper, March.
- Qualified Mortgage, 2013, "Definition of a Qualified Mortgage (QM)." Availablevia the Internet: http://www.qualifiedmortgage.org/definition/.
- Sweet, Charles A., and William R.B. Springer, 2012a, “CFTC Issues Broader Interpretive Exclusion From Commodity Pool Regulation for Certain Securitizations, and Temporary Registration Relief for Securitizations and Other Swap-Based Commodity Pools,” Bingham.com, Legal Alerts, October. Available via the Internet: www.bingham.com/Alerts/2012/10/CFTC-Issues-Exclusion-from-Commodity-Pool- Regulation.
- Sweet, Charles A.; Joshua B. Sterling; and William R. B. Springer. 2012b, “CFTC Issues Broader Interpretive Exclusion From Commodity Pool Regulation for Securitizations, and No- Action Advice ‘Grandfathering’ Some Securitizations and Extending Temporary Registration Relief Until March 31, 2013,” Bingham.com, Legal Alerts, December. Available via the Internet: www.bingham.com/Alerts/2012/12/CFTC-Issues-Broader- Interpretive-Exclusion-From-Commodity-Pool-Regulation-for-Securitizations.

*Italicized source attribution: _wp13255 - REFERENCES (PDF)*

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