Last month the SEC made the unprecedented suggestion that issuers in the private 144a securitization market should be required to provide the same level of disclosure to investors as those issuing in the public market. The suggestion is as damaging as it is surprising.
The fundamental problem is that the proposals treat securitization differently to other types of security. Its treatment would be unique. While there are many in the market and in government that might wholeheartedly sympathise with this aim, it does not mean that it is right for the SEC to pass judgement on one security versus another. If the regulator takes it upon itself to determine the level of disclosure necessary in one private placement market as opposed to another then it could go on to exercise that right in one market after another.
Transparency and disclosure are the endgame for ABS regulation, and rightly so. But disclosure for disclosure’s sake is not the answer. The securitization market did not implode because there was insufficient disclosure in the offering documents. It imploded because investors were buying on rating, the ratings were often based on false assumptions and no one seemed to be reading the offering documents at all.
That is not to say that improved transparency and disclosure have not been necessary and welcome in the public market under Regulation AB. But the private market exists as a complement to the public market, not a carbon copy of it.
However, the argument for requiring public disclosure in the private market can be eloquently made simply by pointing to all the supposedly sophisticated investors that have lost money. They have proved themselves anything but sophisticated. The SEC is, however, forgetting the most remarkable aspect of this downturn: as the scale of the problems in the sub-prime mortgage market was fully realized in the early phase of the crisis correlation in the ABS market went to one. All deals tanked – those with excellent disclosure and those with close to none. Those sophisticated investors in the 144a market have lost money on many deals for which the cashflows are still good and the underlying loans are still performing.
Requiring public disclosure in the private market will dissuade many issuers from entering the market and sharply increase the costs of issuance for those that do. Investors in that market will not be protected against irrational market panic by burdensome disclosure. And the net result of such a move will be the inevitable shutting off of credit to the people whose interests the SEC is supposed to be fostering: the US public.
