If Europe’s sovereign debt is to be securitized, who’s going to earn those origination and packaging profits?

Sir, with respect to the European Systemic Risk Board —recommendations of pooling, packaging and tranching sovereign bonds from all members of the single currency into synthetic securities you opine: “Having a safe asset proposal in the mix would make it less risky, for example, to introduce a sovereign debt restructuring mechanism or risk weights for banks’ government bond holdings.” “Eurozone ‘safe asset’ is crucial to banking union” May 22.

Once securities with mortgages to the subprime housing sector in the US got a high rating, that allowed the originators of very long, very high interest and very lousily awarded mortgages, to sell these of at very low discount rates, and thereby generate huge immediate profits for them and the packagers. Did this benefit in any way the subprime sector? No! On the contrary… it got much more mortgages that it could reasonably swallow.

In the same vein, let me ask, how are subprime rated nations like Greece to benefit by having its public debt packaged together with higher rated nations like Germany? If its debt is sold off in riskier tranches, then all remains the same. If its debt remains in the safer tranches is there then not a build up of a new crisis?

Sir, what Europe does not need is to try to hide away in some new securities, the regulators’ fatal use of risk weighted capital requirements for banks, that which favored way too much sovereign indebtedness. 

What Europe, and the western world need the most is to get rid of that regulation in order to allow banks to again become banks that earn their return on equity by giving loans with calculated risk taking, and not by reducing equity.

A Systemic Risk Board that does not understand the systemic risk bad and intrusive regulations pose is a joke of a Board. 

PS. Yesterday I visited the Bank of England’s Museum

@PerKurowski

Do subprime borrowers or investors in mortgages benefit from securitization? No, now all profits go to intermediaries

Sir, Ben McLannahan, with respect to securitization of subprime mortgages quotes Julian Hebron, head of sales at RPM Mortgage with: “Making credit available to borrowers who are subprime is national policy and it is an important part of economic growth” “Financial crisis: 10 years on: The return of subprime” September 2.

Q. Do the subprime borrowers get any interest reduction from having their mortgages securitized, such reduction that could make these mortgage a safer investments for those investor who acquires these at lower rates? A. No!

Convincing risky Joe to take a $300.000 mortgage at 11 percent for 30 years, packaging it in a security, and then with a little help from the credit rating agencies convincing risk-adverse Fred that this mortgage is so safe that a six percent return is adequate, allows that mortgage to be sold for $510.000.

The $210.000 profit is now shared in it entirety by those originating the subprime mortgage, those packaging it, and those obtaining the excellent credit rating for the resulting security.

If that is “an important part of economic growth” that merits being part of a national policy, I don’t get it. Do you Sir?

If for instance 70% of those profits were paid back to those borrowers who lived up to their obligations, that would indeed imply a different and much more positive incentive structure.

Is that not something like for which cooperatives are often intended but not always achieve?

@PerKurowski

The financial packaging / securitization process includes an evil incentive

Sir, Patrick Jenkins in the Spectrum special “Financial crisis: 10 years on: Where are we now?” September 1 writes: “So great was investors’ appetite for these high-yielding MBSs and CDOs that mortgage companies lowered their underwriting standards to feed the securitisation sausage machine.”

Yes and no! First these MBSs had the additional quality of being rated by the credit rating agencies as very safe, AAA in many cases; and so in fact offered extremely high risk-adjusted yields, which made their great attractiveness perfectly logical. Naturally many investors would fall for these.

But then we have the problem with the securitization process itself. If you package something safe and sell it of as something safer, the profits are much smaller than if you manage to package something very risky and are able to sell it off as safe. So “mortgage companies lowered their underwriting standards”, not only because of the demand, but also because that allowed the original mortgages to carry higher interest rates, and so the profits of the packaging team would be larger larger. Here is how I have described that on my blog for more than a decade.

“If you convinced risky and broke Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with more than a little help from the credit rating agencies, you could convince risk-adverse Fred that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell Fred the mortgage for $510.000. This would allow you and your partners in the set-up, to pocket a tidy profit of $210.000”

@PerKurowski

Caveat emptor, regulators regulating!

Sir, I refer to Shahien Nasiripour and Tom Braithwaite’s report “Credit Suisse faces NY lawsuit” November 20, in order to comment on the temptations that existed (and still exist) for someone doing wrong, when awarding and packaging mortgages to the subprime sector. 

The natural incentive: If you convinced risky Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with more than a little help from the credit rating agencies, you could convince risk-adverse Hans that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell the mortgage for $510.000 and pocket immediately a tidy profit of $210.000. 

The regulatory incentive: If banks invested in such AAA rated securities, or lent against it as collateral, then according to Basel II, they needed to hold only 1.6 percent of a very loosely defined capital, which amounted to allowing banks a mind-blowing 62.5 to 1 leverage of its very loosely defined capital. 

And the combination of these two incentives to create “The Infallible” proved too irresistible for many, like for Credit Suisse. Only Europe, over just a couple of years, invested over a trillion dollars in these securities. I am not clearing mortgage originators, mortgage packagers, security credit raters and investment banks of any of their responsibility, but are not those regulators who provided the irresistible temptations also at fault? 

The sad part of the story is that the possible cost of this sort of lawsuits will now have to be paid including by those who bear no blame for the disaster, like “The Risky”, like the small business and entrepreneurs, those with interest earning bank deposits, and taxpayers. 

From now on, besides notices on the door indicating a bank to be insured, we might also need to put up a sign stating “Caveat emptor, regulators regulating!”