FT's Martin Wolf on Securitisation: life after death

[GRG55]

Here's a link to an interesting column by the FT's Martin Wolf, one of the more astute and readable economic journalists. The debate about how to maintain the benefits of securitisation while addressing the obvious flaws revealed by recent excesses is just getting started.

Securitisation: life after death

By Martin Wolf
Published: October 2 2007 18:49 | Last updated: October 2 2007 18:49


“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Chuck Prince, Financial Times, July 10 2007.


“A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” John Maynard Keynes, 1931.

The dance has stopped: Mr Prince’s Citigroup has just announced $6bn (€4.2bn, £2.9bn) in write-downs and losses for the third quarter of 2007. He is far from alone. More bad news is no doubt to come. As Keynes foretold, the banks joined Mr Prince’s dance together and are leaving it together. Until the dance ends, nobody knows what a bank’s profits are: bankers report (and pay themselves) on the basis of profits that are normally offset by write-offs when the bad lending comes to light.

What is remarkable about the present crisis is how traditional it is, despite the modern paraphernalia of securitised lending. We are seeing old-fashioned bad lending and old-fashioned mispricing of risk.

Link to article:
http://www.ft.com/cms/s/0/8dd50650-7...0779fd2ac.html

[quigleydoor]

Re: FT's Martin Wolf on Securitisation: life after death

If these markets are to recover, the errors must be fixed: first, a way must be found to demonstrate integrity of lending; second, transparency of the securities will have to increase; and, third, banks must insure themselves adequately against the need to provide liquidity to their off-balance-sheet vehicles. It is not impossible to sell complex products safely: Boeing and Airbus manage it. But only companies that demonstrably care about their reputations are able to do so. It is up to originators of securitised liabilities to do the same.

How are the trustworthy ABS originators going to establish their good reputations? It looks like an opportunity for the credit rating agencies to step in. But the ratings agencies were complicit in this whole mess as well. So it seems to me we need to fix the credit rating system before Wolf's idea can take off.

Are any other groups or companies ready to help by examining and scoring the quality of the ABS originators?

[jk]

Re: FT's Martin Wolf on Securitisation: life after death

the other part of a solution will be for the abs originators to retain some of the risk. putting their own money on the line will encourage better lending practices.

[GRG55]

Re: FT's Martin Wolf on Securitisation: life after death

How are the trustworthy ABS originators going to establish their good reputations? It looks like an opportunity for the credit rating agencies to step in. But the ratings agencies were complicit in this whole mess as well. So it seems to me we need to fix the credit rating system before Wolf's idea can take off.

Are any other groups or companies ready to help by examining and scoring the quality of the ABS originators?

One would think that the ratings agencies AND the Wall St investment banks that knowingly peddled (what they openly referred to as) "toxic waste", would all go the same way as Arthur Andersen, on the premise that, in their businesses, reputation means everything. In another age and time that is exactly what would have happened under these circumstances. However, reputations can be trashed and clients looted, as it simply doesn't seem to matter - at least not yet. Note that Goldman and Morgan are busily raising funds to buy back the same securities they previously created and marketed to clients, presumably at a steep discount.

In our modern world there is (IMHO) an insalubrious regard for superficial celebrity and individuals able to garner vast accumulations of money in a remarkably short span of time. Our societies reserve a distinct form of awe for those with the most predatory behaviour - what I disparage as the "Icahn becomes an icon" syndrome.

None of this is likely to change very quickly. In the meantime, buyers of credit are probably going to have to do what they used to "in the old days" - develop their own internal credit assessment capability.

[c1ue]

Re: FT's Martin Wolf on Securitisation: life after death

One would think that the ratings agencies AND the Wall St investment banks that knowingly peddled (what they openly referred to as) "toxic waste", would all go the same way as Arthur Andersen, on the premise that, in their businesses, reputation means everything. In another age and time that is exactly what would have happened under these circumstances. However, reputations can be trashed and clients looted, as it simply doesn't seem to matter - at least not yet.

Don't worry, we're just at the first stage.

Does anyone REALLY think $6B is all that Citi has lost from the collapse of the (subprime, Alt-A, new junk bond) securitization business?

Furthermore the debasement of the dollar is absolutely going to affect foreign buying of US securities - this on top of the subprime ABS scandal will absolutely reduce volumes and thus profits.

We're at the first (and largest) dead cat bounce.

The R.E. news is getting grimmer by the month - the masses haven't yet figured out that this means the bank financial situation is going to get even worse - and that this round of 'losses' is just what the banks HAVE to declare.

[GRG55]

Re: FT's Martin Wolf on Securitisation: life after death

the other part of a solution will be for the abs originators to retain some of the risk. putting their own money on the line will encourage better lending practices.

Here's an idea that's worth discussing IMHO...
Stephen Cecchetti is a is professor of economics and finance at the Brandeis International Business School

A better way to organise securities markets
By Stephen Cecchetti
Published: October 4 2007 19:53 | Last updated: October 4 2007 19:53


In September 2006 Amaranth Advisors, a US-based hedge fund specialising in trading energy futures, lost roughly $6bn (£3bn) of the $9bn it was managing and was liquidated. With the exception of its shareholders, most people watched with detached amusement. Eight years earlier, reaction to the impending collapse of Long-Term Capital Management was very different: people were horrified and the financial community sprang into action. One big difference is that Amaranth was engaged in trading natural gas futures contracts on an organised exchange, while LTCM’s exposures were concentrated in thousands of interest-rate swaps.

After LTCM’s collapse, people thought hard about the structure of financial institutions. What information disclosure should be required? What rules should officials implement to ensure that an institution’s failure does not put the entire system at risk?

But the recent turmoil suggests we should think again. Comparing 1998 and 2006 suggests that this time we should look for lessons about the way securities markets are organised.

Link to FT article:
http://www.ft.com/cms/s/0/fc9a4f48-7...0779fd2ac.html

[jacobdcoates]

Re: FT's Martin Wolf on Securitisation: life after death

Don't worry, we're just at the first stage.

Does anyone REALLY think $6B is all that Citi has lost from the collapse of the (subprime, Alt-A, new junk bond) securitization business?

Furthermore the debasement of the dollar is absolutely going to affect foreign buying of US securities - this on top of the subprime ABS scandal will absolutely reduce volumes and thus profits.

We're at the first (and largest) dead cat bounce.

The R.E. news is getting grimmer by the month - the masses haven't yet figured out that this means the bank financial situation is going to get even worse - and that this round of 'losses' is just what the banks HAVE to declare.

I think that will change c1ue, NPR ran a news story during rush hour about a local bank failure due to the sub prime debacle, if I remember correctly it was Miami Bank(OH not FL) that was declared insolvent by the state and taken over by the FDIC this morning. Many more stories like that during rush hour and people will wise up fast... The small fish die first and float in a toxic pond, then come the bigger fish.

[GRG55]

Re: FT's Martin Wolf on Securitisation: life after death

I think that will change c1ue, NPR ran a news story during rush hour about a local bank failure due to the sub prime debacle, if I remember correctly it was Miami Bank(OH not FL) that was declared insolvent by the state and taken over by the FDIC this morning. Many more stories like that during rush hour and people will wise up fast... The small fish die first and float in a toxic pond, then come the bigger fish.

Here's the press release from the FDIC (emphasis mine):
FDIC Approves the Assumption of the Insured Deposits of Miami Valley Bank, Lakeview, Ohio



The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) today approved the assumption of the insured deposits of Miami Valley Bank, Lakeview, Ohio, by The Citizens Banking Company, Sandusky, Ohio.

Miami Valley, with $86.7 million in total assets and $76 million in total deposits as of October 1, 2007, was closed today by Ohio's Superintendent of Financial Institutions, and the FDIC was named receiver.

The failed bank's two offices will reopen tomorrow as branches of The Citizens Banking Company. Depositors of Miami Valley will automatically become depositors of the assuming bank.

The Citizens Banking Company has agreed to assume $62 million of the failed bank's insured deposits for a two percent premium. At the time of closing, Miami Valley had approximately $14 million in 269 deposit accounts that exceeded the federal deposit insurance limit. While these customers will have access to their insured deposits, they will become creditors of the receivership for the amount of their uninsured funds. The FDIC will retain all of Miami Valley's assets for later disposition.

Customers with questions about how deposit insurance works or who would like more information about the failure can visit the FDIC's Web site at http://www.fdic.gov/bank/individual/failed/miamivalley.html or call the FDIC toll-free at 1-800-451-1093. The toll-free number will be operational daily from 9:00 a.m. to 10:00 p.m., Eastern Daylight Time.
The FDIC estimates the cost of this transaction to its Deposit Insurance Fund to be approximately $3 million. Miami Valley is the third FDIC-insured bank to fail this year, and the first in Ohio since Oakwood Deposit Bank, Oakwood, Ohio, was closed on February 1, 2002.

[jacobdcoates]

Re: FT's Martin Wolf on Securitisation: life after death

Thanks again GRG55, IT was the second bank failure due to the sub prime mess that I have heard of(netbank being the first).

I think the article in your post GRG55, is the author suggesting that we close the barn door after the horses left.

I think that the best regulatory action would be common sense, if such a think still exists. if you don't know how to value something don't buy it or buy it very cheaply. Granted something must be done to minimize systemic risk to the financial system, regulations will have unintended consequences, they always do. Not regulating where it is need has significant drawback also. I think it would be better to look at the regulation in light of amaranth and LTCM, after the fireball dims a bit were kind of temporally blinded right now, trying to duck and cover instinctively.

if you all in bed together and have the same reputation, does it really matter if you partner has a bad reputation. It's like a hound dog and sleeping with a slut, neither party has much room to broach the subject of propriety. So I don't think wall street or the rating agencies will care all that much, they will just try and keep mum about it and hope that no one notices.

[jk]

Re: FT's Martin Wolf on Securitisation: life after death

the existence of the ratings agencies is protected, in large degree, by the fact that they have become institutionalized in many contracts and legal arrangements. many trusts and pension plans, for example, can only invest in investment grade bonds, and "investment grade" is defined as carrying certain labels from the ratings agencies. thus the agencies are guaranteed business. i would imagine, however, that there are legal actions now in the making which will further impair their value.

[FRED]

Re: FT's Martin Wolf on Securitisation: life after death

the existence of the ratings agencies is protected, in large degree, by the fact that they have become institutionalized in many contracts and legal arrangements. many trusts and pension plans, for example, can only invest in investment grade bonds, and "investment grade" is defined as carrying certain labels from the ratings agencies. thus the agencies are guaranteed business. i would imagine, however, that there are legal actions now in the making which will further impair their value.

Dr. Hudson indicated in his previous interview here that he'd heard that law suits by the governments of Germany and France, I believe, in defense of sovereign funds that purchased the mis-rated securities as well as suits alleging violation of securities and other laws in sales of these to pension funds are in progress. Not sure if this is widely known yet.

[jacobdcoates]

Re: FT's Martin Wolf on Securitisation: life after death

That is interesting, hadn't heard that till now, wonder how far it will get. Probably not deathblow hard, though. If they did then they would have to come up with some other way to rate securities and bonds? Creating something from whole cloth is a lot harder than I think politicians are will to work at the problem to fix it.

[c1ue]

Re: FT's Martin Wolf on Securitisation: life after death

The ratings agency problems are simply that they've created an ecosystem which inherently puts the agencies into an ethical violation.

On the consumer side: previously the ratings agencies were stodgy businesses catering exclusively to professional organizations.

The individual would never see this credit score unless he was buying a house or engaging in some other activity where someone else ran a credit report on him.

However, now the agencies all offer consumer services based on selling/monitoring/improving credit scores to individuals.

This now creates a feedback loop where credit-hungry individuals will find ways to game the credit score system to feed their credit needs. We've already moved into the next stage where now professional agencies are helping them doing it.

The result is a 'credit arms race' where credit scoring criteria will change, then the professional 'credit builders' will find new ways.

The result will be several cycles of back and forth, likely culminating in lenders refusing to use credit scores.

That is, unless the credit agencies give up their consumer business.

Given that $751m out of $1990m of Experian's revenue in 2007 was from 'Consumer Direct' services (with double digit growth), I'm not seeing this latter possibility happening any time soon.

On the corporate services side, the failure to adequately model MBS'/CDOs - possibly due to conflict of interest - are well documented in iTulip already.