Today’s Daily Angle comes from Wikinvest Wire member Yves Smith of Naked Capitalism. You can read the full article on NakedCapitalism.com

As readers may know, the financial reforms proposed by the Obama administration barely deserve the name. The late-in-the-game efforts to rebrand the effort by putting Paul Volcker in the forefront and patch up one of the gaping holes, that the government is backstopping risky trading businesses (Goldman Sachs has issued FDIC guaranteed bonds) illustrates the typical Obama chasm between rhetoric and action.

So it was a pleasant surprise to learn that the FDIC presented a cogent and tough-minded plan for securtization reform at the American Securitization Forum. Surprisingly, I haven’t seen a write-up at my usual first stop for this sort of thing (Housing Wire) and a search of my RSS reader shows no posts on this “advanced proposal of new rulemaking” which was made public back in December.

This is clearly a topic of keen interest; an estimated 1000 people attended Michael Krimminger, Deputy to the Chairman for Policy at the FDIC’s presentation and follow-up panel discussion. I’ve been skeptical of various ideas to “fix” securitization, but this one would do the trick. And it will also have the effect inherent to any program to restrain profligate and irresponsible lending: it will reduce credit extension and increase costs to the industry. That’s a feature, not a bug. But many incumbents seem unable to accept that a return to healthy practices means an end to cheapcredit.

Given all the attention to Volcker’s proposals, I’m amazed that this FDIC proposal has gone virtually unnoticed. Yes, Volcker is a big name and Krimminger isn’t, but bad mortgage lending, which took place primarily through securtizations, was at the heart of the crisis. How is this story not important?

In addition, this FDIC proposal supports two of my other pet theories. One is that it is possible for regulators to come up with effective reforms if they have the will. This is a cogent and well designed plan. Second is the FDIC is the only Federal banking overseer that takes regulation seriously (the SEC might have once upon a time; it might be possible for it to rebuild that skill. The Fed is beyond redemption here; it is dominated by monetary economists who not only don’t know what they don’t know, but also are unduly respectful of the wonders of financial markets. The FDIC, by contrast, is not overawed by banksters).

I’m at a bit of a disadvantage by not having attended the presentation; I’ve also read the FDIC notice and hope between it and the comments received from some people who did attend the panel that I am presenting the FDIC plan accurately.

The driving element is that the FDIC is proposing to change the requirements for a securitization to be treated as a true sale, meaning that when the originator sells the mortgages to a securitization vehicle (say a trust), the investors in that vehicle cannot go back to the originator for recourse. Banks also need a “true sale” treatment for accounting and regulatory purposes; otherwise, they’d have to report their interest in the mortgages on their balance sheets and hold equity against the exposure.

The FDIC proposed these major changes (these are high-level summaries; comments encouraged):

1. Mortgages must be seasoned 12 months before they can be securitized
2. The originator must retain at least a 5% interest in the credit risk of the assets sold
3. The interest of all parties to a transaction must clearly be disclosed, along with their fees
4. Re-securitizations (meaning CDOs) are not permitted (note a disconnect here; the e-mailed and verbal reports suggested they were banned entirely; the language at the FDIC website seems to indicate that they are allowed in limited circumstances, but any use of synthetic assets, meaning credit default swaps, in a asset-backed CDO is verboten)
5. Compensation to servicers will include incentives for loss mitigation

This is an elegant little list. I had been critical of earlier proposals that merely called for originators to retain a 5% interest as being too small an economic stake to change behavior sufficiently. But in combination with the 12 month seasoning requirement, it require the originators to bear a fair amount of risk. Indeed, as we have found out, a high proportion of the loans that went boom did so in the first year. This change would force banks to up their game considerably as far as borrower screening is concerned.

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