Securitisation is not dead. By Michael Heise, chief economist Allianz Group/Dresdner Bank
Crises change markets. The Savings & Loans crisis pushed US banks into securitising mortgages; the European ERM crisis ultimately gave birth to the euro; the Asian debt crisis shifted the policy debate in the emerging markets and eventually strengthened them. These are some examples of past experience. What will change after the latest financial crisis? Or more specifically, what will happen to securitisation?
The economics of securitisation are still valid. From an economist’s point of view, it makes perfect sense to shift credit risks around. It enables banks to originate new loans and it offers investors a new asset class with attractive risk-return profiles. It is a much more efficient way to get exposure to credit risk than, say, by investing in bank stocks or deposits.
However, the subprime debacle made clear that something was rotten in the state of securitisation. The problems start when ever more complicated structures (CDOs and the like) are used to create AAA securities out of patchy assets. Such financial engineering can work if the valuing of underlying assets is done correctly. However, more often than not financial engineering degenerates into “financial alchemy” aimed more at obfuscating the quality of underlying assets. Initially, it brings huge benefits: the higher the rating the lower the capital requirements for holding such securities. Thus, investors can use a higher leverage.
And problems finally get out of hand when such “structured” loans are not sold to real money investors but shifted into the unregulated world of hedge funds, SIVs and conduits. These are leveraged investors sui generis and rely heavily on short-term financing.