I can’t stand it. We now have skin in the game provisions proposed by the SEC, the FDIC, the House of Representatives and the United States Senate.
On CNN the other day, Congressman Barney Frank said that the most important part of the House Financial Reform bill was skin in the game in securitization. Okay, I know we’re probably stuck with it and the world will not end. Capital formation will be modestly depressed and the geniuses on the Street will work overtime to mitigate the impact of all that excess capital sloshing around. But it pains me to give up the fight. Skin in the game is certainly an attractive slogan and, superficially, it makes a great deal of sense. But no one has really looked at the data. The worst performing sector in the fixed income world was, without doubt, loans to developers, builders and the like. All of this lending activity was on book or, in the skin in the game parlance; the lenders had nothing but skin in the game.
Hello! Lehman failed. Bear failed. Merrill failed (more or less). The GSEs don’t even bear thinking about. All of this carnage happened not because the institutions were brilliantly successful in laying off bad credit to dumb investors, but because they had skin in the game. In the CMBS sector, mortgage loan originators generally sold 100% of the risk of the loans they originated, and the sector is experiencing losses generally consistent or somewhat better than the performance of commercial real estate taken as a whole. Again, explain to me how skin in the game is going to fix this?
Moreover, all of the legislative and regulatory proposals also go out of the way to demand the lenders do not hedge the skin. Huh? Didn’t we just finish castigating the banking sector for mismanaging risk? So now we’re giving notice that such negligence is obligatory? I don’t get it.
The fascination with skin amounts to misdirection. It sucks the air out of a debate on other steps which could get at the real problem. Let’s think about underwriting standards, for goodness sakes.
The SEC, in its recent request for comment to its proposed ABS rule asked for input on whether the structure of CMBS, with a hard-nosed B-piece buyer at the bottom of the capital stack, is a good way to achieve the benefits promised by skin in the game. Maybe the final regulations will embrace that view. That would represent adult leadership. But, the political wisemen tell me, no chance, we’re stuck with skin in the game. Another great idea brought to us through the bounty of the populist sound byte.
