Risk retention and how to regulate it
Thursday 1 September 2011 - by Kim Shafer
Risk retention makes intuitive sense. If a securitiser has ongoing risk of loss, typically referred to as "skin in the game", then that party will presumably originate loans with greater care.
For a more extensive discussion of the parallels and differences between ABS CDOs and CLOs, how CLOs exacerbated the loan bubble, and more extensive comments on the proposed regulations, see this CFS paper here.
Similar to mortgages, the institutional segment of the leveraged loan market became an originate-to-distribute market; banks would syndicate loans on terms based on institutional investor demand and CLOs were over 60 per cent of that demand (in 2003 through the first half of 2007).
Loan quality deteriorated as the credit bubble grew, and CLOs by their nature exacerbated the bubble. The reasons CLOs exacerbated the loan bubble have everything to do with misaligned interests. The reasons they did not perform as disastrously as mortgages and ABS CDOs has everything to do with the relative quality and veracity of loan information in contradistinction to mortgage information.
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