Securitisation and the global financial crisis: Can risk retention prevent another crisis?

Abstract

Prima facie securitisation played a prominent role in the recent global financial crisis. Moral hazard associated with securitisation is the key element behind the failure of securitisation. Risk retention is the US legislator's response to address the moral hazard issue associated with the originate-to-distribute model. This paper adopts a lexieconomic framework to analyse the risk retention provisions of the Dodd-Frank Act and proves that said provisions are not capable of eliminating moral hazard associated with securitisation. This paper argues that in order to ensure proper screening of the borrower, the cost for the lender for not engaging in proper screening and monitoring should be higher than the benefits she gains by not screening. Inter alia this paper further argues that the inclusion of non-recourse mortgages would make securitisation schemes susceptible to changes in home prices.