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Abstract

Relaxed lending standards, lending without retaining residual risk, and financial engineering led to a large expansion of mortgage credit that resulted in the over-origination and over-leveraging of poor quality mortgage securities products in the years leading up to the 2008 financial crisis. The over-origination of these poor quality assets has been attributed to a lack of skin-in-the-game by the parties making lending and structuring decisions in the securitization chain. The proposed credit risk retention rules, promulgated pursuant to Section 941 of the Dodd-Frank Act, attempt to fix the flaws in the residential mortgage securitization process that led to the financial crisis by closely aligning the economic interests of parties in the securitization chain, namely by crafting the Qualified Residential Mortgage (“QRM”) safe-harbor to risk retention narrowly, and by prohibiting a securitizer from profiting off of a securitization pool that ultimately fails by establishing a premium capture cash reserve account. These proposed rules are currently under attack by a variety of commentators who seek to expand the definition of the QRM safe-harbor and ease other restrictions associated with the proposed rulemaking. This Comment examines the proposed credit risk retention rules as they apply to residential mortgages and considers responses to the rules from consumer advocates, politicians, trade groups, and financiers. In spite of the opposition to the proposed rules, this Comment urges regulators to maintain most elements of the proposed rulemaking, including the narrow QRM definition and restrictions on hedging because they attack certain crucial problems that contributed to the recent financial crisis. However, this Comment proposes a modification of the premium capture cash reserve account concept in a manner that would better encourage private label extension of safe credit.

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