Richard Barley has a very depressing column today which begins like this:
Bankers and policy makers agree on the need to revive the securitization market to enable banks to roll over a big chunk of their existing wholesale funding.
If that doesn’t make a lot of sense to you, well, it didn’t make much sense to me either. But let’s rewind a little here, and remind ourselves of the two different types of securitization.
The first type, which is the type I think of when I listen to people talking about “the need to revive the securitization market”, is the securitization of existing real-world cashflows, like car payments or mortgage payments or even David Bowie royalties. Bankers get involved in this market primarily as intermediaries: they talk to the owner of the cashflows (the auto finance company, say, or David Bowie), structure a deal, get it rated, and then sell the bonds to investors. For this they get fee income — but in no sense can that fee income be considered “wholesale funding”.
Then there’s the second type, in which banks securitize their own assets — the loans which they made to their own customers. This kind of securitization makes much less sense. During the boom, a lot of this type of securitization took the form of “synthetic CDOs”, where the banks kept the loans on their own balance sheet and did clever things with credit default swaps to seemingly get rid of all the associated risk. We know how that turned out.
Alternatively, banks sometimes decided to get into the “originate to distribute” business, which was pretty much the single biggest cause of the subprime crisis: because they weren’t going to be holding on to most of the loan, they didn’t seem to care much about old-fashioned things like underwriting quality.
Sometimes, banks did just decide to sell off bits and pieces of their balance sheet by selling loans. This didn’t happen very often during the crisis, since no one was particularly worried about balance sheets getting too big. But when it did happen, the banks sometimes decided to turn to the securitization market rather than simply selling the loans to other banks as they had done for centuries. Was that because they wanted to tap bond investors and thereby increase the potential investor base for the loans? Not really. Barley explains the real reason:
U.S. banks have been subject to a leverage ratio all along, making them keen issuers of securitizations to offload assets, but reluctant holders of triple-A-rated assets, which used up balance sheet for little return. European banks, on the other hand, faced no gross leverage constraints but were regulated according to the Basel II capital rules, which encouraged them to load up with triple-A-rated assets because these carried a very low risk-weighting.
In other words, it was all regulatory arbitrage. Securitization didn’t decrease the total amount of leverage in the banking system as a whole — in fact, it probably increased leverage, by parking assets at European banks who could hold them more or less cost-free as a result of those assets’ triple-A credit ratings.
But in any case, running down the list, it’s still pretty hard to see how securitization could really be considered a funding source. The point of securitization is that you sell assets (after converting them to bonds) — you don’t borrow against them. Conceivably synthetic CDOs might be considered a funding source, but surely no one wants to go back to them.
The one thing which is absolutely clear is that banks should never be in the business of securitizing loans and selling them to other banks. If you want to sell loans to other banks, just do so directly, by syndicating or participating out the loan. Going the securitization route is expensive enough that the only way it makes sense is if there’s some kind of regulatory arbitrage going on, and we don’t want that.
Looking at what’s happening to bond spreads, it’s conceivable that there’s now a bid out there again, among real-money bond investors, for securitized loans. If that’s true, then maybe a few banks could start testing the waters. But insofar as the business of banks securitizing loans to each other has now died, it should never be resuscitated.