Regulating Moral Hazard: The True Risk of Dodd-Frank\u27s Risk Retention Requirement

Dodd–Frank was implemented in response to the Great Recession as a means to curb abuses on Wall Street. The Act mandated broad reform of the financial system, and in particular, required regulators to promulgate rules controlling the complex structure of Asset-Backed Security (ABS). Dodd–Frank required securitizers to retain a portion of the credit risk associated with ABS. The goal was to curb moral hazard—the market failure commonly blamed for the Financial Crisis. However, there is reason to believe Dodd–Frank may “not adequately address” the moral hazard problem. In Part I, this Article will set forth the nuts and bolts of ABS, identify risks associated with ABS, and describe Dodd–Frank’s solution to the systemic problems associated with ABS. Part II will critique Dodd–Frank and the Agencies’ solution to the moral hazard problem. Finally, Part III proposes a narrowly tailored method for reducing moral hazard via a precise risk retention requirement