Reflexions on the Future of Financial Securitization

Transcription

1 1 Reflexions on the Future of Financial Securitization Jean-Michel BEACCO, CEO, Institut Louis Bachelier, Head of Post-Crisis Finance Chair, Collège de France Tokyo, Monday, November 16, 2009 Imperial Hotel

2 Brief history (I) 2

3 Brief history (II) 3

4 The Project: a Securitization «White Paper» 4 Concept EIF has launched a contribution to current reflexions on the securitization business, which will result in the production of a «white paper» Between article and book: easy to read but exhaustive Main perspective: the investor s Objectives Draw a balance of securitization Compensate for a current void in literature Put forward recommendations Layout Global overview Economic functions of securitization Vices and virtues of the OTD business model Securitization s role in the current crisis Recommendations

5 Originate-to-Distribute: an improper Business Model? 5 The OTD model shifted responsibilities and generated wrong incentives Initially well adapted (allowed for increased liquidity and better risk allocation) Surge in the origination of risky loans, especially for housing structured into riskier securities (poor screening) Agency problems: agencies and third-parties were paid by originators As products complexified and unskilled investors arrived on the market, the sophistication gap widened

6 Control and Regulation Inadequacies 6 Reputational effects allowed investors and issuers to collude against regulators through regulatory arbitrage Risk was not properly allocated Internal Risk Management: deliberately overoptimistic? Bonus and responsibility schemes favored short-term (shadow) profits over long-term investments Due to lack of hindsight on complex securitization performance, internal risk models were only partially reliable and not flexible enough to cope with large variations Credit Rating Agencies, under competitive pressure, failed to distinguish accurately between the riskiness of different securities Which augmented the procyclicality of the crisis, as investors fled to qualiry when the first high-rated securities started defaulting Regulatory laxism and shortcomings Basel I made regulatory arbitrage based on securitization attractive for banks Reliance on rating was officially favored by Basel II, which ignored systematic risk by focusing on the monitoring of exogenous shocks on individual banks. National supervisors were prone to overindulgence to favor «their» institutions Monetary policy conditions and responses proved uneffective

7 Self-Augmenting Mechanisms 7 Credit rating agencies delivered inaccurate ratings with excess confidence Which may be due to blatant conflicts of interests The illusion of liquidity abundance on securitization markets collapsed and resulted in a flight to quality Northern Rock: liquid liabilities vs. illiquid assets Mark-to-market valuation increased the confidence crisis and forced banks to sell off assets Securitization risk was carried by unadapted final investors Fannie & Freddie were directly engaged on over 50% of mortgage-associated risks Credit risk transfer increased the issuer s systematic risk All the more hazardous since the shadow banking system was unregulated

8 Tomorrow s Securitization (1/4): CRAs as public service Description Organizations wishing to officially rate securities register with an ad hoc regulator Issuers in need of a rating directly contact this regulator, which determines the appropriate fee and independently picks out the rating agency The fee could be determined either based on (current) market prices, or on a cost plus basis, Dumping would be prohibited 8 An agency s licence could be withdrawn based on technical or statistical criteria Extension: NUS Risk Management Institute s selective Wikipedia model Advantages End of conflicts of interests between CRAs and issuers, which would lead to renewed investor trust Strong incentives for agencies No eviction effect for small investors Drawbacks Difficult implementation in political terms Risks linked to collusion between the agencies

9 Tomorrow s Securitization (2/4): Strong Investors versus Strong Originators Description For the time being, structurers work as an oligopoly and face smaller, sometimes unsophisticated investors. To eliminate these information asymmetries, investors could gather under the lead of a First-rank investor Either a simple syndicator, i.e. an independent intermediary (model A) or a seeder, bringing in capital to the gathering 9 This FRI would have the power to deal with originators on equal terms and carry out rating and similar tasks directly Advantages Reputational effects would be effective even with small final investors If a model B FRI assumes servicing tasks, elimination of another agency problem No eviction effect for small investors Drawbacks Predatory and collusion risks organizational costs, coordination costs if more than one FRI

10 Tomorrow s Securitization (3/4): a new Glass-Steagall Act Description Ban on confusion between different fonctions along the securitization value chain: Origination and structuration on the one side... Those functions are already largely distinct, especially for mortgages 10 Underwriting on the other side (the underwriter would have to take some vis-a-vis the investors) Restriction of CRA activities to sheer rating (similarly to audit regulation after the Enron scandal) Advantages Most of the previous, stronger model s advantages... With smaller associated costs Drawbacks Requires monitoring the agencies to avoid information loss Hard to guarantee underwriters effective independence

11 Tomorrow s Securitization (4/4): complete separation between loan origination and holding Basic argument: banks have recently acquired the opportunity to hedge the risk associated with the equity tranche through Credit Default Swaps, offsetting positions, macroeconomic risk management => no point in forcing them to keep it According to the strict securitization logic, draw a strict line between origination and conservation 11 Advantages: No illusionary guarantee Investors only have to «screen» loans Specialization of banks in their core business Drawbacks: Requires minimally sophisticated investors, else wrong incentives for banks