Document Type

Article

Publication Date

8-21-2019

Abstract

This Article takes the occasion of the tenth anniversary of the financial crisis to review recent developments in the structured products market, connecting the emergent pattern to post-crisis regulation.

The Article tells a tale of two markets. The financial crisis stemmed from excessive risk-taking and shabby practice in the subprime home mortgage market, a market that owed its existence to the private-label, originate to securitize model. But the pre-crisis boom in private label subprime mortgage-backed securities could never have happened absent back up financing from an array of structured products and vehicles created in the capital markets—the CDOs that found their way into CDO squareds, SIVs, and synthetics, magnifying subprime credit risk and carrying it into the system’s vulnerable nodes where the bailouts occurred in 2008. The post-crisis regulatory pattern shifts the emphasis back from the end point in the causation chain (magnified risk and bailouts) to the start point (residential mortgage origination and securitization). It is only at the start point, in the world populated by consumers and their immediate counterparties, that we find anything like new prohibitions. The capital markets side of the picture is touched much more lightly. Even so, at a quick glance today’s structured products market looks like a qualitatively different place—subprime RMBS, CDOs, CDO squareds, CDO-based synthetics and SIVs are all gone. This Article takes a closer and longer look at today’s structured products market to show that the difference between now and then is more a matter of degree. The new regulatory landscape for structured products has definite borders, and it is at just those borders where the beat of financial innovation and regulatory arbitrage goes on. This activity is not centered at the banks, for there private label originate-to-securitize and investment in private label products is affirmatively discouraged by post-crisis regulation. Today’s innovation in structured products occurs at the more lightly-regulated nonbanks, which are displacing the banks at the riskier end of the residential mortgage and corporate lending markets.

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