Monday, September 21, 2009

IMF defends securitisation markets

Posted on the Financial Times website by Chris Giles:

Restarting securitisation markets is “critical” to a wider economic recovery, the International Monetary Fund claimed on Monday as it warned new regulatory proposals might kill the market.

The Fund welcomed efforts to tame many of the pre-crisis excesses in securitisation markets, which have been blamed for allowing money to flow to households that had little chance of paying it back, but signalled that the current proposals were too draconian.

“As these proposals currently stand ... they may be so blunt that they will either be ineffective at providing incentives for better securitiser behaviour, or alternatively may further slow the market recovery, effectively closing it under some configurations of portfolio characteristics and economic conditions,” the Fund said.

The private sector market for new securitisation has collapsed since the financial crisis started in 2007. It seeks to parcel up individual loans offered by banks to customers and sell them en masse to investors including pension funds and insurance companies which are often able and willing to manage the risks.

The Fund insisted the market’s resumption is “critical to limiting the real sector fallout from the credit crisis amid financial sector deleveraging pressures,” in the analytical chapters of its twice-yearly Global Financial Stability Report.

It said that in spite of the disastrous consequences in the crisis, distributing credit risks to investors outside the banking system still would place risks with those best able and willing to manage it.

Before the market’s collapse, asset-backed securities and covered bonds provided between 20 and 60 per cent of the funding for new residential mortgage loans originating in the US, Western Europe, Japan and Australia.

The crisis was caused in large part as a result of incompatible incentives regarding securitisations. Banks made money from fees rather than the performance of loans.

They did not not take adequate care in originating loans because they wanted to pass them on quickly. Credit ratings agencies underestimated the risk of the products, often keen to earn fees in rating products. Banking regulation gave financial institutions incentives to hold securitised loans in off balance sheet vehicles. And the products were excessively complex.

The Fund supported many of the changes to rules and regulations that will address these problems, calling for much more standardised products. “Policies should not aim to take markets back to their high octane levels of 2005–07, but rather to put them on a solid and sustainable footing,” it said.

But it was particularly concerned about US and European proposals to force banks that originated loans to hold on to the first 5 per cent of losses in all securitisations. This idea, the Fund said, was not flexible enough and might backfire.

In bundles of low credit-quality loans, originators would always expect to lose the full 5 per cent portion in a downturn and would still have no incentive to screen those applying for loans, the Fund said.

It indicated that a more sophisticated policy to keep the originators’ “skin in the game” was required, which would depend on the credit quality of the underlying loans.

In another chapter of the GFSR, the Fund called on governments to wait until there is “lasting confidence in the health of financial institutions and markets” before withdrawing the emergency interventions to support financial markets.

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