Canada: Regulatory Overkill, American Style

Emerging from the vast literature generated by the recent financial crisis are two competing narratives attempting to identify the root cause of the crisis. One, emanating from the more conservative side of the political spectrum, emphasizes the role played by governmental policies encouraging and subsidizing the expansion of home ownership among middle and low income households. The other side focuses on the extent to which a free market philosophy came to dominate governmental thinking and led to deregulation and hence catastrophe. Although it will be crucial, from a policy perspective, to eventually ascertain just exactly what were the main drivers of the crisis, due to entrenched partisan and dogmatic differences, it may not be possible to do so until we have achieved some historical perspective. However, what does appear to be common to both narratives is that governmental actions, or, perhaps more precisely, their unintended consequences, were in some way heavily implicated.

Apart from anything else, what the foregoing might suggest is that governments should be cautious about its interventions in the market place. Rather than grand, sweeping reforms, the long-term effects of which governments have notoriously unable to accurately anticipate, what may be  called for are more surgical, incremental reforms, which, if necessary, can be revisited and adjusted from time to time as their effects become manifest.

Nevertheless, and at the risk of setting up a straw man, the position taken by U.S. regulators in respect of the ABS market appears to be that, while the last crisis may well have occurred as a result of problems specific to the real estate sector, as no one can predict the source of the next contagion, it is best to take vigorous prophylactic measures across the board now. Accordingly, they have been widely accused of, and abused for, taking a "one-size-fits all" approach pursuant to which they have crafted rules of universal application.

This approach has attracted vociferous criticism the main line of which generally goes as follows: The financial crisis occurred as a result of poor asset quality due to the application of the originate-to-distribute model characteristic of the RMBS/CMBS sector. The other, non-mortgage-backed sectors, do not use this model and investors in these sectors experienced no spike in losses during the crisis. To apply a solution crafted to address the unique problems of the RMBS/CMBS sectors to these other sectors is both unfair and unnecessary and will lead to the suffocation of those markets.

Despite sympathy for the foregoing, I am not quite sure that it entirely responds to the regulatory position, which is not to say that that position is justified. Perhaps the issue can be better approached from a slightly different angle, one that is based on the proposition that the crisis was symptomatic of a series of faulty credit decisions which made up a chain of events, each link of which was comprised of an aggregation of credit decisions each of which in turn was characterized by a fundamental lack of prudence.

The first link was comprised of decisions made by mortgage originators who advanced loans to borrowers based, in the most extreme cases, on little or no down payment, no documentation, no proof of income and, ultimately, fraud. Whatever the ultimate root-cause of these decisions, it is clear to most, including the regulators, that what stoked them was the enormous demand for product, any product, by investors. Hence, the motivation to originate for the sole purpose of distribution. By not retaining any of the risk, by not keeping any skin in the game, the originators were incentivized to worry less (or not at all) about product quality and more (or entirely) about product quantity, knowing they could pass any losses on.

The next link was characterized by the credit decisions made by purchasers of the mortgages and the issuers of securities backed by the mortgages. The fault with these decisions lay in the lack of proper due diligence on underwriting standards being applied by originators and thus the quality of the purchased mortgages as well as a failure to adequately disclose to purchasers of the securities the problematic underwriting standards and poor asset quality. Their level of imprudence may also in large part be attributable to a belief that they could also pass any problems on to investors. (It has always been a source of some wonder to me that some of the biggest players were nevertheless caught with an enormous amount of these assets/securities when the crisis arose . I am inclined to believe that this was a result of bad timing more than anything else.)

The last link in the credit chain was inhabited by investors in MBS who failed to ensure that they understood the product in which they were investing and their true exposure to faulty underwriting standards, relying too heavily on the credit analysis provided by rating agencies which have subsequently been accused of being hired enablers rather than reliable gate-keepers.

The regulators have consistently maintained that their goals in crafting the ABS proposals were two-fold: to protect investors while at the same time recognizing the importance of maintaining the securitization industry in order not to compromise the availability of credit to consumers. They have been accused, however, of paying little more than lip service to the latter and the solutions evidenced by their proposals would seem to support this accusation.

Accordingly, they have chosen to mandate prudence at each link in the chain. First, they impose prudence on originators by requiring them to have skin-in-the-game and by devising complex and expensive mechanisms to police the accuracy of representations and warranties. Second, they impose prudence on purchasers/issuers by requiring burdensome asset level disclosure and asset reviews. Third, they attempt to impose prudence on investors by attempting to dislodge their reliance on the credit analysis provided by the rating agencies and substituting therefore requirements of doubtful utility or value such as waterfall computer programs and cash-flow certification.

It should, however, have been apparent that the crisis would never have occurred unless each link in the chain of credit decisions leading to it had been faulty. In other words, without all three levels of imprudent credit decisions there would have been no crisis and the final two links are rooted in and totally derivative of (albeit compounding) the original set of credit decisions involving the failure to apply prudent underwriting standards. What necessarily follows from this is that regulators should have been able to achieve their goal of protecting investors by causing a break in the "chain of imprudence" at any single link rather than by taking a shotgun approach which will necessarily involve extensive collateral damage.

For instance, in those sectors, such as autos and credit cards, in which there is no historical evidence of the imprudent application of less than rigorous underwriting standards, and which have historically had both corporate and structural incentives to the exercise of appropriate levels of prudence in the origination of loans,  there is no justification at all for imposing further costs and burdens by the application of rules which have been specifically crafted to address a model and to correct abuses not shared by these sectors. The evil at which the rules are aimed simply did not and does not exist in these sectors. The application of these rules will create no further benefits and will entail only further costs, which should perhaps be viewed as a bright line test for regulatory overkill. Only if and when these other sectors were to evolve in the direction of the RMBS/CMBS sector would the application of similar rules to them be justifiable.

Once the issue of imprudent underwriting standards is satisfied either, in the case of autos and credit cards, by finding no evidence of the application of such imprudent standards, or,  in the case of RMBS/CBMS, by application of the new rules (assuming for present purposes that such rules are adequate and effective for such purposes) the chain of imprudence will have been effectively broken and there is no justification for the imposition of further burdens down the credit chain for the same reason: they will bring no extra benefit but will entail heavy costs. This is especially true for such artificial constructs as the proposed waterfall computer program and cash-flow certification.  (While it may be argued that mandating adequate disclosure (the second link in the chain) should thus be sufficient in the case of RMBS/CMBS, there may be other reasons why it is preferable to instead regulate at the origination link given the levels of malfeasance in the form of predatory lending which seem to have been all too common during the heyday of the crisis.) 

Perhaps a medical analogy is the most fitting conclusion: The regulators have it within their means to neutralize the cancer by the  simple excision of an identifiable tumour; but instead they seem to be insistent upon extensive radioactive and chemical therapy which, while it will certainly eliminate the tumour, may well kill the patient.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.