One of the things we\’re told about the recent financial troubles is that all of this securitisation was one of the causes of it.
People made loans and then flogged them off as bonds instead of hanging on to said loans until maturity.
However, there\’s one thing that rather militates against this story.
No, not that securitisation, flogging off the loans, led to lower quality loans being made (that\’s a slightly different question) but that too many people flogged off said loans. Actually, the problem in the financial markets was that not enough people flogged off said loans.
When the music stopped and the dancers started looking around at the inadequate number of chairs left, some still had great steaming piles of those securitised loans on their books. That\’s why those banks fell over. If they had really been sold on then the economic loss would have been the same of course: but the financial system wouldn\’t have frozen over. It would have been private investors (few of them though), insurance companies, pension funds, which took the hit of losing…but the losses would have been rather less as the prices were, during the crash, deeply depressed by the fact that every bank was trying to unload at the same time.
This isn\’t to say that such a result would have been perfect of course: but if the banks really had flogged on those securitised loans, as they were supposed to, we\’d have had a recession, yes, a housing collapse, yes, but not a financial system collapse. And it\’s that last that marks out recent events as being different from previous asset bubble collapses.
So we can argue that it was insufficient securitisation, assuming that there\’s going to be any bonds at all rather than direct loans held to maturity, which caused the problems.
OK, that\’s all past stuff: but it has great relevance to sovereign debts problems here in Europe.
Arguably, places like Greece, Portugal, Spain, should get out of the euro, devalue, default (even if only partially, by redenominating into the new local currencies) and then get on with life.
But they cannot be allowed to do that: because it\’s the banks which hold great wodges of this debt that they\’ll be defaulting upon. So the entire European banking system (I exaggerate) will fall over and that cost would be far greater than having to stump up a trillion or two to help out the PIIGS.
However, if the banks had not bought and held the bonds but had, as a proper securitised market would ensure, simply facilitated the trade of those bonds onto long term investors then we wouldn\’t have this problem. Yes, of course, we\’d still have the same losses on defaulted bonds, losses which would need to be absorbed somewhere, but we wouldn\’t have a banking system with the potential to implode.
Which leads to a policy prescription. We should be insisting on legally binding full securitisation. No bank (our definition of a bank here being someone with a banking licence, thus someone able to tap deposit protection schemes, central bank liquidity windows etc) should be allowed to hold any portion of a loan that they or any other such bank has originated. All such loans must be turned into bonds which must find a home with terminal investors (who can then go on and trade them to their hearts\’ content).
We\’re not going to stop asset bubbles or incontinent governments in the future after all: but we might be able to stop such bringing down the entire financial structure.
So, what are the powers that be doing at present? Yup, the EU and others are insisting that any originator of a loan must hold 5% of it to maturity. They\’re actually insisting that banks must do in the future what has just caused the last fuck up.
It\’s said of generals that they\’re always ready to fight the last war. It takes politicians to insist that we\’ll be ready to lose the last one.