Banks May Keep Skin in the Game

By LIZ RAPPAPORT and CARRICK MOLLENKAMP

LAS VEGAS -- An emerging plan to ensure that banks sell high-quality securities underpinned by well-underwritten mortgages is being met with criticism by some regulators and industry experts.

The proposal, which is only under consideration and still in the early stages, would call for issuers of pools of mortgage loans to retain a slice of the debt, which is created through a process called securitization. In simple terms, banks would be required to keep some "skin in the game."

A wave of mortgage securitizations in 2005 through 2007 is now seen as a key culprit of the housing mess because banks created and then sold billions of dollars of securities without conducting due diligence on individual loans within the pools. Those offerings helped fuel the surge in housing sales in the U.S. and Europe and ultimately led to the global financial crisis.

The $8.7 trillion securitization market, which also helped fund credit cards and auto loans, is largely dead, forcing the U.S. government to put into place plans such as the Term Asset-backed Securities Loan Facility, or TALF. At the American Securitization Forum's annual conference this week in Las Vegas, where the outlook largely is grim, industry participants are discussing with regulators other ways to bring investors back to buy debt pools. On Monday, several panels also tackled the TALF plan and whether or not it will help shore up the securitization markets.

The central topic Monday was the plan to make banks keep a piece of the debt pool. Typically, debt pools are sliced into pieces or tranches based on risk and returns. Opponents of forcing banks to keep a debt slice point to the fact that banks such as UBS AG, Citigroup Inc. and Merrill Lynch & Co. kept the top layers of more complex debt pools known as collateralized debt obligations and then ended up writing down tens of billions of dollars.

Some regulators are behind an effort to force banks and mortgage originators to take more responsibility for what they sell. Sandra Thompson, director of the division of supervision and consumer protection at the Federal Deposit Insurance Corp., said in a speech Monday, "everyone involved should have some skin in the game."

Some at the ASF conference said Monday that forcing banks to keep debt slices could further upend the shaky market while also forcing banks to tie up precious bank capital. The consideration is gaining support in Europe where regulators are debating whether lenders should keep as much as 10% of the loans they originate in an effort to encourage responsible loan underwriting.

Matthew Eichner, a senior adviser at the Federal Reserve Board's division of research and statistics in Washington, questioned whether rules about retaining exposures will address the real issues that helped topple the mortgage market -- a lack of due diligence and misplaced incentives.

"There is skepticism on the Fed staff that if we structure things that way it will distract from the real issue of due diligence," Mr. Eichner said.

Write to Liz Rappaport at liz.rappaport@wsj.com and Carrick Mollenkamp at carrick.mollenkamp@wsj.com