The Dodd-Frank Wall Street Reform and Consumer Protection Act requires the Chairman of the Financial Stability Oversight Council, or FSOC, to issue a study on the Dodd-Frank Act’s risk retention requirements within 180 days of enactment. This risk retention study was delivered to Congress on January 18, 2011 and examines the ways that risk retention, also known as “skin in the game,” can, according to its authors, help reform the securitization market, protect the public and the economy against irresponsible lending practices, and facilitate economic growth by allowing for safe and stable credit formation for consumers, businesses, and homeowners.
The governmental regulators which conducted the study noted the following (which views are not uniformly shared by the author of this article):
- The study notes that asset-backed securitization provides important economic benefits by improving the availability and affordability of credit to a diverse group of consumers, businesses, and homeowners.
- However, as the recent financial crisis demonstrated, without reform, risks in the securitization process can detract from these benefits. Leading up to the recent crisis, originators and securitizers made loans, bundled them together, and then sold them off to a broad array of outside investors, often without retaining a meaningful share of the risk. Because originators had little interest in whether the borrowers would be able to repay the loans, underwriting standards deteriorated and excessively risky mortgages flooded the market. This helped fuel the financial crisis.
- To address this serious flaw in the pre-crisis securitization market, the Dodd-Frank Act generally requires that securitizers or originators have “skin in the game” by retaining at least 5 percent of the credit risk of an asset sold to investors through the securitization process, which should allow market participants to price credit risk more accurately and allocate capital more efficiently.
- By putting in place such safeguards, the Dodd-Frank Act can help ensure that securitization is a stable and reliable source of credit for consumers, businesses, and homeowners in the United States.
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