Hayek, the True Sale Doctrine, and the Origins of the Financial Crisis

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7 Responses

  1. Jeff Lipshaw says:

    Nate, I didn’t have to see your name on the RSS feed to know that this HAD to be your post.

    This is your key move:

    “One way of getting around this problem is for the originator — that is the bank that initially sold the mortgage loans to the SPV — to provide “credit enhancements” in the form of letters of credit, put options, or the like. All of these devices ultimately consist of a promise that the bank will pay the SPV the face value of the underlying mortgage loan if the actual home buyer defaults.”

    I don’t think your second sentence follows. Not all credit enhancements are created equal, at least in terms of remoteness, or true sale. I can see an argument that the SPV’s right to put the instrument back to the bank undercuts a true sale, but a letter of credit or a credit default swap is the promise of a third party to step up and pay. That’s not a promise of the bank to pay, and hence I don’t see that it undercuts the “sale.”

  2. Nate Oman says:

    Jeff: I completely agree. I am over simplifying here to ease the exposition, but obviously you can have credit enhancements that don’t amount to guarantees. On the other hand, credit enhancements that DO amount to guarantees by the originator such as put options that let SPV’s require that banks repurchase non-performing loans at face value WERE very common. The same would be true if a bank issued a letter of credit on its own originated assets.

    The point of the post is that the absence of a real true sale test for “bankruptcy”* remoteness in banking transactions eliminated an important incentive for originators to adopt credit enhancements that pushed risk on to third parties.

    Certainly it seems to be the case that one of the big problems the banks face is that many of them, despite following an originate-to-distribute model find themselves in the position of in effect insuring the loans they had supposedly unloaded. One — not the only or even the most important but, nevertheless, one — reason for this may have been that doing so didn’t undermine their ability to promise investors “bankruptcy” remoteness.

    *”Bankrtupcy remoteness” is the wrong term here, since banks aren’t subject to the bankruptcy code. Perhaps “insolvency proceedings remoteness”?

  3. Nate Oman says:

    Another de facto guarantee was to retain the equity tranche but book it at some inflated value based on an over-optimistic assessment of the risk of default on the underlying assets. When the assets fail to perform, you take a write down which is the equivalent of a payment.

  4. Bruce Boyden says:

    When was sec. 360.6(b) added?

  5. Nate Oman says:

    September, 2000

  6. Andrea Mertz says:

    Do you have any urls of a true sale opinion letter? I am currently doing research on these letters and need to read an example. Thanks.

  7. Martin Perrone says:

    How many true sales must a loan go through before it can properly be placed in a REMIC trust? (Properly securitized)