Regulators Coming to their Senses About Skin-in-the-Game?

Last week, the Wall Street Journal ran an article detailing some of the latest discussions among regulators at the US Federal Reserve and the Federal Deposit Insurance Corporation related to the Dodd-Frank inspired rule that would require issuers of residential mortgage-backed debt to retain 5% of the value of loans in the program. 

More commonly known as “skin-in-the-game”, this half-baked solution to abuse in the US RMBS markets may have run its course and interestingly enough, before it actually becomes fully implemented.

The reasons are fairly obvious.  Just the threat of this additional “cost of issuance”, when combined with all the other regulatory uncertainties facing mortgage originators and other MBS arrangers has been enough to shock the private mbs market into a ghost of its former self.  Now it seems that these effects are finally sinking in with US regulators.  They may now see that the cure may actually be worse than the disease. 

Earlier in the year, the regulators signaled their intentions to scrap the “20% down-payment” or “QRM” rule.  Now the suggestion is that the other component to skin-in-the-game, the 5% retention rule, may now only apply to loans that are of an “interest-only” nature. 

While they are at it, can’t they just kill the whole thing and admit that the skin-in-the-game idea was a bad one from the beginning.  For more than four years, we have been saying that the issuers of mortgage-backed securities already have a ton of skin-in-the-game.  Their business models depend on a free-flowing source of capital that can only be found in a well-oiled mortgage-backed securities marketplace. 

This will never be more true then when the GSE’s are wound down over the next few years.  Right now they are the only game in town.  It has taken the regulators a few years to take note or perhaps they needed time to build their case.  Either way, it’s time to put a stick in this rule.