Dollars and Jens
Wednesday, April 08, 2009
how bank regulation exacerbated the crisis
Felix Salmon picks up a report from Goldman Sachs that gets concrete about some points that have been made elsewhere:
On the left hand side is the amount of capital that a bank would need to have if it had $100 of mortgages on its balance sheet: 5%, or $5. Once it securitizes those mortgages and they become RMBS, however, the capital needed drops to $4.10.

Of the $4.10, 40 cents is comprised of capital provisions against the triple-B tranche of the RMBS. But if the bank then repackages that triple-B tranche into a CDO, that capital requirement drops still further, to 35.5 cents.
Arnold Kling has suggested that securitization would not have happened were it not for these perverse incentives, and I have disagreed; I think there's a lot of good to be done in pooling loans and tranching them up to target different investor risk preferences. I don't at all think that justifies bad regulation to promote it; if anything, I'd like to see more stringent requirements for the securities than the loans to encourage banks to keep exposure to the loans they originate.


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