Q&A: Mayer Brown's Jason Kravitt calls for better regulatory coordination
Regulators are being asked to lighten up on securitization, but for many of them, the product remains too opaque. Who’s winning the regulatory tug of war, and why can't global regulators rise above local politics? GlobalCapital caught up with Jason Kravitt, founder of Mayer Brown’s securitization practice, to find out.
GlobalCapital: What are the main obstacles to the development of high quality securitizations?
Jason Kravitt, partner, Mayer Brown: Two problems. The first is defining it. There is no consensus on how to define it and that is very, very difficult. The Bank of England and European Central Bank paper that was just released had a very interesting way to define it, which is a securitization where the investor can, through transparency, accurately predict the risks that it is taking. I had never heard that before and I think a lot of people could live with that.
The second issue is the US versus Europe, or Europe versus the US. For the most part people in Europe want it, and for the most part people in the States don’t want it. People in the industry in Europe tend to want it because the market really hasn’t taken off, it’s just gotten along, and they feel that if you institute a high quality securitization badge that the market will take off. So they’re more interested in building up what needs to be built up.
In the US the market has come back except for subprime RMBS so they’re afraid that if you had a high quality securitization filter you would actually cut back a lot of things that are doing fine now – that it would either make them more expensive or difficult to issue. Bridging that gap is as difficult and important a challenge as defining what a high quality securitization is.
GC: When it comes to things like risk retention, some people say that the market will always find a way around any rule. Is there a way around risk retention?
Kravitt: I don’t agree that it doesn’t matter what the rules are because you’ll always find a way around it. I think bad rules influence behaviour and good rules influence behaviour.
At my panel I started out by saying I had listened to a paper by a French regulator whose research showed that when the rules got “too strict” people behaved much more riskily to try and get around the rules, whereas if the market perceived the rules as fair they didn’t engage in risky behaviour trying to get around them. Rules actually influence behaviour. I think it makes a difference.
Secondly, rules affect pricing. Take a look at the US – in the risk retention rule we had qualified mortgages and non-qualified mortgages. Everybody believes that if you qualify the financing will be cheaper and the market will be deeper, and they believe if you don’t qualify you can sell the mortgages but they’ll be more expensive and the market won’t be as liquid. So I don’t think you can say that if you get around the rule, the rule doesn’t have any affect.
GC: Do you think we are already starting to see a rolling back of some of the harsh treatment securitization suffered after the crisis?
Kravitt: Basel has a chance to lighten up because they haven’t adopted final rules. They don’t have a final set of ratios, they don’t have a final calibration of risk-based capital. They still have a lot of opportunity to not be as harsh as was originally proposed.
But I think something like retention is hard to change. Volcker is very, very hard to change. And I don’t think the Americans are having as much second thoughts as the Europeans are having, because the Europeans are having to deal with a market that’s not taking off. They’re trying to explore more options, because what they have so far isn’t working.
GC: When it comes to Volcker, the OCC, for example, seems to be more hard-line than other regulators implementing the rule. Do you think that regulators in the US have run out of patience with Wall Street complaining that without certain fixes — like for CLOs, for example — the market will implode?
Kravitt: No matter the human endeavour there are always people saying the sky is going to fall. I don’t think the market tends to exaggerate a lot and I think that the regulators are very open-minded when it comes to listening to the market.
We don’t always change their mind but I don’t think I’ve ever dealt with a regulator in this area that wasn’t trying to do the right thing. It may not come out the way the industry views as the right thing, and history may teach us that it wasn’t the right thing, but I don’t think it’s because they’re closed-minded or have lost patience.
I also think the industry learned a lesson, to a certain extent, not to try and go too far. Nobody claims we didn’t need new rules.
Here’s an interesting concept: most of the laws that have been passed have tried to influence behaviour. Retention, Volcker, disclosure…they all want you to behave better. But risk-based capital is a defence no matter how you behave, so there’s a belt and suspenders — you have new rules influencing your behaviour but we also want to add extra capital in case you don’t behave. So I think we’ve got too many safeguards now that duplicate each other.
GC: How long is it before the pre-crisis headiness takes over and we see a return to things like CDOs cubed? Some people think it’s inevitable. Has that kind of innovation been regulated away, or is there a chance that those structures could return?
Kravitt: That is where I agree with whoever said no matter what the rules are you can find a way around them. If you want to take a lot of risk, you can always figure out a way to take a lot of risk. The issue is how significant a part of the market will it be and will the market be able to sustain some riskiness without falling apart.
One thing I always like to quote is that during the tech bust, $7tr of value was lost. In the financial crisis, $1tr of value was lost. But the tech bust barely harmed anyone’s economy. Seven times the losses as came up during the financial crisis. How do you explain the difference?
The difference is that people who bought all that tech stock weren’t leveraged, so they could bear the losses. But financial institutions owned all this stuff that turned out to be poorly underwritten and they were excessively leveraged. Bear Stearns was leveraged 40 to one. Then the next entity that failed was Lehman Brothers, and they were leveraged 35 to one. Merrill would have been next but BofA popped up.
Financial institutions are better-capitalised now, and they can bear a little more risk than they could at that time. But they’re not capitalised so that no matter what happens they can bear the risk. It always has to do with how much of the market is engaging in extremely risky behaviour in relation to how well the market is capitalised. I think for a long time we’re going to be adequately capitalisd and the amount of risky beahvour will be small enough that the market won’t be threatened, but you would have to be a fool to predict that there is never going to be another financial crisis. But I don’t think it’s over the horizon.
GC: When this conference comes around next year, what do you think will be the most important topic?
Kravitt: I think we’ll still be talking about high quality securitization. We’ve got to work through those two challenges and it takes more than a year to do that. One problem we have had is just a lack of coordination.
GC: Do you think that is improving, for example with the joint ECB and BoE paper?
Kravitt: That’s within Europe though, not between Europe and the US. Most of the lack of coordination is between Europe and the US, because the US and Europe is still where most of the world’s financial regulation originates. It’s such a difficult problem.
I went around with trade associations in 2008, maybe 2007, visiting the different regulators in Europe and North America, and they all said don’t worry, we’re going to coordinate better, that’s one of our principal goals. And then what did they do? Local politics in every case trumped coordination. So the question is do we ever get about local politics? I don’t know. It’s very, very difficult.