Securitisation made market less stable, says FSA
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Adair Turner, chairman of the Financial Services Authority says the demand that used to exist for securitisation may never return because it made the market less stable.
Speaking at the LSE Future of Finance conference today, Turner says while securitisation had the potential to disperse and reduce risks, it interacted with the specific risk characteristics of banks to make the whole system less stable.
He says: “In the confident pre-crisis conventional wisdom, securitised and structured credit and related credit derivatives were lauded as a new financial technology, which was both increasing allocative efficiency and reducing risks.
“But while in theory securitised credit could have achieved risk reduction, its particular implementation undermined that potential and it simultaneously created a new and dangerous source of instability.”
By the early 21st century securitised credit had grown to account for over 50% of all US home mortgages, 25% of US commercial mortgages and consumer credit, and in the UK over 20% of home mortgages.
Turner says it not only enabled investors to select assets more precisely tailored to their own specific risk return preferences but it enabled banks to better diversify risk; originating loans but then distributing some of them to end investors, so that banks no longer needed to hold portfolios determined by their own specific regional or client base.
He says as a result, it was believed, securitisation made possible a more stable financial system.
He adds: “Part of what went wrong, however, was that neither of these supposed benefits was actually delivered.
“When the music stopped in 2008 a large share of credit securities turned out to be held on the trading books of banks –banks which had originated and distributed credit with one hand had then bought back other bank’s credit securities with the other hand, encouraged to do so by utterly inadequate capital requirements against trading assets.”
Turner says specific faults in the system can be addressed by better regulation – though as a result, much of the demand for securitised credit instruments may never return.
Readers' comments (7)
Anonymous | 14 Jul 2010 2:17 pm
Ok Lord Adair your point is taken but having allowed securitisation to get out of control leading to a distorted market, how exactly do you propose to fix the current situation without it. There is not enough money held on deposit to fund the appetite for lending. I suppose you will cut adrift anybody who requires a mortgage as from your Ivory Tower I am sure it will be inconsequential anyway.
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Anonymous | 14 Jul 2010 2:35 pm
The ratings agencies were to blame for triple A stamping toxic CDO's. Securitisation is fine so long as investors have accurate information. However, with the complete absence of sub-prime and self-cert products, is there a market for securitisation anymore?
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Danny Lovey | 14 Jul 2010 2:44 pm
It never ceases to amaze me how long it takes the FSA to work out the bleed... obvious!
Henry Hindsight is always a smart fellow, but the FSA have even smarter fellows that it takes even longer to work out where things went wrong. By the way Mr Turner it was not securitisation in itself that was the main problem, as the vehicle has been around for donkey's years, it has everything to do with American toxic mortgages for people who should never have been given them being repackaged by American Investment Banks and stuffing investors around the world with alledged AAA securities. Like most trends in the States these things spread across the pond, although I do not believe that our industry came anywhere close to the bad practice by those in the USA.
Maybe we should sue the Americans for dumping their environmental toxic debt on our shores and ask Mr Obama for a trillion dollars to clear up the American mess!
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Dark Haired Underwriter | 14 Jul 2010 2:58 pm
re Anonymous@2.35pm
The complete absence of sub prime products is a direct consequence of the securitisation market no longer being willing to accept these types of risk/bonds. That added to much stronger capital adequacy requirements means no spare liquidity for organisations to invest in this type of product [or certainly at a price the market would accept].
In my opinion there is still a significant demand for "sub prime" and this demand will increase as general interest/mortgage rates increase. At some point the investor will be able to obtain the required margin as the demand for this type of mortgage will increase to the point where the consumer is willing to pay the price. Unlikely that self cert will ever return to types that existed in 2007 [and that should be viewed as a good thing by all concerned] but there will always be room for lender innovation e.g. will they/wont they accept management accounts, is depreciation a reasonable cost that could be added to profit, is cost of development a reasonable add back etc.
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Anonymous | 14 Jul 2010 3:04 pm
Securitisation to blame? You must be joking...Blame the gun for the murder; blame the ocean for the drowned swimmer...The rating agencies were not fully culpable; it was investors seeking excess yield and lenders willing to bend the rules.
They say that nothing beats a pig to the trough, and this time it was no exception.
Securitisations are complex instruments, and some of the most vocal investor critics used to buy residuals on securitisations (imagine how complex that must be) in an afternoon. That's how stupid it got. "Wasn't my fault...!!" is the hew and cry of many of these same investors.
There are plenty of others who remain steadfast supporters, and, for the most part, these deals are performing as expected, apart from their secondary market prices.
Has anyone looked at the "high yield" (aka “junk") market lately? Do all of these bonds pay off and does anyone buy them initially at par with the thought that they’re only getting 5p to the £ back? Has every AAA-rated bond remained that way forever? No...that's why they call it risk.
We were all guilty of excessive optimism at one point in that cycle, but choking off a legitimate source of funding to find a scapegoat is nearly criminal.
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chris jones | 14 Jul 2010 9:33 pm
as an ex sub prime underwriter for most of the big players in the uk i would urge you read "Fiasco" by Frank Partnoy. It explains very well how weve got to where we are now. youl then understand why securitisation is unlikely to return. (just in case there are any brokers left out there waiting for an upturn) do yourselves a favour, forget it, get a new job.
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Anonymous | 15 Jul 2010 12:20 pm
Are the FSA going to impose huge fines upon themselves for "failing to ensure staff acting on its behalf had adequate understanding of the markeT" ? I suppose they have paid the price for being useless by being abolished!!!
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