EU has taken some extraordinary regulatory steps lately. Some of those steps are surely coming too late, though! And I say that despite being an opponent of all sorts of government intervention in the market place. OK, in the dream world there would be no intervention by politicians and other know-nothings but, now, we don’t live in the dream world, in case someone had missed out on that, and in the real world more of the good kind of regulation can sometimes be better than less of the bad kind.
As is well known, EU has decided to regulate credit rating agencies and credit default swap markets. However, now they have gone further. One of the last steps taken by EU is to pass a law that forces banks to retain 5% of the securitized products originated by the bank. That wasn’t a day too late!!!! Why the regulators didn’t understand, already back in the pre-crisis days, that being lenient on banks when it comes to them keeping some of the risk they securitize on their own books, beats me! It was the whole idea of the CDO, for instance!
As I explain in my article Byström, H., (2008), The Microfinance Collateralized Debt Obligation: a Modern Robin Hood?, World Development. 36 (11), 2008, pp 2109-2126. one of the nice features of the CDO (and its tranching) is the possibility it gives uninformed investors to rely on the originator not selling them lemons by allowing (forcing?) the originator to keep some of the risk itself. How come this idea got stuck in the academic community and wasn’t spread to the regulators and supervisors?
Anyway, better late than never (the rules will be implemented next year)! Let’s hope these new capital provisions will enable the securitization market to wake up from the dead soon….