CLE Materials for Panel #1 - George Washington University Law ...

WILMARTH
4/1/2011 1:11 PM
972 OREGON LAW REVIEW [Vol. 89, 951
nonbank lenders and CRAs who worked with LCFIs) collected
lucrative fees at each stage of originating, securitizing, rating and
marketing the risky residential mortgages, commercial mortgages,
credit card loans, and LBO loans. 71 Based on the widespread belief
that LCFIs were following an “originate to distribute” strategy, both
managers and regulators of LCFIs operated under the illusion that the
credit risks inherent in the securitized loans were being transferred to
the ultimate purchasers of structured-finance securities. 72 In
significant ways, however, LCFIs actually pursued an “originate to
not really distribute” program, in which they retained significant risk
exposures from their securitization programs. 73
For example, LCFIs decided to keep large amounts of highly rated,
structured-finance securities on their balance sheets because
regulators allowed LCFIs to do so with a minimum of capital. In the
U.S., LCFIs took advantage of a regulation issued by the federal
banking agencies in November 2001, which greatly reduced the riskbased
capital charge for structured-finance securities rated “AAA” or
“AA” by CRAs. The 2001 regulation assigned a risk weighting of
only 20% to such securities in determining the amount of risk-based
capital that banks were required to hold. 74 As a practical matter, the
2001 rule cut the risk-based capital requirement for highly rated
tranches of RMBS and related CDOs from 4% to only 1.6%. 75
In Europe, LCFIs similarly retained AAA-rated structured-finance
securities on their balance sheets because the Basel I and Basel II
capital accords assigned very low risk weights to such securities. In
contrast to the United States, European nations did not require banks
to maintain a minimum leverage capital ratio and instead required
banks only to meet the Basel risk-weighted capital standards. As a
result, European banks did not incur significant capital charges for
71 Crotty, supra note 33, at 565–66; Wilmarth, supra note 4, at 984–87, 995–96, 1017–
20, 1034–42; see also id. at 995 (noting that “[f]ee income at the largest U.S. banks
(including BofA, Chase and Citigroup) rose from 40% of total earnings in 1995 to 76% of
total earnings in 2007”).
72 Wilmarth, supra note 4, at 995–96, 1025–26, 1041–42.
73 Id. at 970–71, 1032–35, 1039–43, 1046–48; see also Acharya & Richardson, supra
note 34, at 198–201; FIN.SERVS.AUTH., supra note 56, at 15–21.
74 See Risk-Based Capital Guidelines, 66 Fed. Reg. 59,614, 59,625–27 (Nov. 29, 2001);
ARNOLD KLING, NOT WHAT THEY HAD IN MIND: A HISTORY OF POLICIES THAT
PRODUCED THE FINANCIAL CRISIS OF 2008, at 25–26 (2009), available at http://ssrn.com
/abstract=1474430.
75 KLING, supra note 74, at 25 fig.4.