Regulatory arbitrage of the day, re-remic edition

By Felix Salmon
October 1, 2009
primer on re-remics today, explaining the regulatory arbitrage at the heart of such deals. Just like capital requirements can drop simply by reclassifying loans as bonds, they can also drop if you play around with bonds and turn them into economically-identical other bonds, which carry different credit ratings. Yes, one would have thought that we'd put an end to such shenanigans by now. And now, we haven't.

" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

The WSJ has a good primer on re-remics today, explaining the regulatory arbitrage at the heart of such deals. Just like capital requirements can drop simply by reclassifying loans as bonds, they can also drop if you play around with bonds and turn them into economically-identical other bonds, which carry different credit ratings. Yes, one would have thought that we’d put an end to such shenanigans by now. And no, we haven’t.

The whole re-remic phenomenon is made even more suspicious, of course, by the fact that bankers, lawyers, and ratings agencies are all charging substantial fees for the work involved. Insofar as they’re creating any value at all, which is doubtful, they’re doing so by creating brand-new structured products with triple-A credit ratings: they’re ratifying the very demand for nominally risk-free assets which lay at the heart of the credit bubble to begin with.

If these things were really attracting new demand, that would be one thing — and indeed Treasury might try to revamp PPIP so as to create liquid triple-A-rated tranches of groups of formerly-distressed assets. But there’s very little evidence that re-remics are being traded: they’re still sitting on the same balance sheets where they’ve been stuck for the past year. They’re just considered a bit less risky, now that some of their AAAs have been regained. How silly.

3 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

i picked up the wsj this morning, looked at the infographic with that story, and thought they’d accidentally delivered a paper from two and a half years ago, from some alternate future where the journal put stories on dodgy risk-hiding schemes above the fold.

In Box 2.3 of the October 2009 IMF Global Financial Stability Report we conclude that “although Re-Remics and similar repackaging transactions are playing useful roles in dealing with the legacy asset overhang, they also serve to illustrate the vulnerability of ratings-based regulations to gaming and shopping.” I’ve been looking for the smoking gun of ratings arbitrage and shopping for some years ago, and this is about close as I’ve seen to a smoking gun.

Posted by Kiffmeister | Report as abusive

“If these things were really attracting new demand, that would be one thing — and indeed Treasury might try to revamp PPIP so as to create liquid triple-A-rated tranches of groups of formerly-distressed assets.”

Care to elaborate on what that “one thing” is? You seem to be suggesting that if AAA-rated tranches of securitized assets were to “attract new demand”, then somehow the taint of regulatory arbitrage is wiped clean.

I’ll proffer again my solution to this flavor of regulatory arbitrage: that in any securitization, the regulatory capital requirements for the securitized pool be held constant both ex-post and ex-ante securitization. Capital requirements should travel with the risk, no matter how it is sliced and diced. If you want to use securitization to reorganize the risk profile of a pool of assets (be they loans, bonds, mortgages, other securitized products, or whatever), the aggregate capital requirement for the securities backed by that pool should equal the aggregate capital requirement of the pool prior to it’s having been sprinkled with securitization-flavor pixie dust. And for fun, let’s call it the law of conservation of regulatory capital.