Your guest columnist Satyajit Das, a former derivatives banker and author, helpfully reminded us of Canadian-American economist JK Galbraith’s dictum regarding financial innovation from his book A Short History of Financial Euphoria. Namely that financial innovations are less innovation and more a twist on a past financial concept or product, unknown to a new generation of speculators.
And so it is with securitisation and its embarrassing cousins collateralised debt obligations (“Magical thinking on CLOs hides leverage risks”, Markets Insight, October 21).
The earliest securitisation deal of which I am aware was a real estate-backed bond transaction that closed in Silesia in 1769 (a forerunner of the Pfandbriefe covered bond, no doubt).
The more fundamental technique of borrowing against an income stream dates back at least to England’s King Edward I (Longshanks) in the 13th century, whose borrowing from the Ricciardi family in Lucca was secured by a tariff on wool.
And the practice of dividing a loan into separate amounts of different seniority in the capital structure is as old as the hills: it is hard to think of many non-investment grade loans that do not do that.
One of the great features of debt secured by assets and divided into senior and subordinated positions is that it is an ancient technique. Old things often work best. So it was that during the entire financial crisis, the level of credit defaults in rated European term residential mortgage-backed securities and asset-backed securities was nil. You read that right: nil.
The staggering financial losses incurred during the financial crisis arose largely out of the widespread fraud in the US residential mortgage and securitisation markets, and its overly complex and fragrant cousins of securitisation (try CDO-cubed or maybe just a simple CDO collateralised exclusively by subprime first-loss assets) and the consequent market losses (for which read “market panic”).
So, while Das is right to flag risks arising out of complexity and opacity, he should refrain from uttering as truisms things that are not at all the case, such as “when hedging credit risk, ideally the entire exposure should be assumed by an unrelated party”.
Nor should he besmirch the sound and venerable technique of securitisation by suggesting that it is a cloak (“ . . . securitisation can help disguise weaknesses of banks unable to generate internal capital because of low profitability or structural problems.”)
Keep it old, keep it simple, keep it clear.
Marke Raines
Managing Director
MAJOR SecReg (Publishing)
Harrogate, North Yorkshire, UK
