Be happy about the lack of securitization

October 7, 2009
Paul Krugman has a good response to Jenny Anderson's piece today on the woeful state of the securitization markets: isn't that a good thing?

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Paul Krugman has a good response to Jenny Anderson’s piece today on the woeful state of the securitization markets: isn’t that a good thing?

Here’s my question: why does it have to be a return to shadow banking? The banks don’t need to sell securitized debt to make loans — they could start lending out of all those excess reserves they currently hold. Or to put it differently, by the numbers there’s no obvious reason we shouldn’t be seeking a return to traditional banking, with banks making and holding loans, as the way to restart credit markets. Yet the assumption at the Fed seems to be that this isn’t an option — that the only way to go is back to the securitized debt market of the years just before the crisis.

Why? Are we still convinced that securitization is a far superior system to conventional banking, and if so why?

Another way to look at this is to ask what’s happening at the big institutional investors who drove the securitization market. If they’re insisting on underwriting loans all of a sudden, and actually wanting to understand who they’re lending to, that’s a good thing too. Here’s James Kwak:

The boom in securitization was based on investors’ willingness to believe what investment banks and credit rating agencies said about these securities. Buying a mortgage-backed security is making a loan. Ordinarily you don’t loan money to someone without proving to yourself that he is going to pay you back (or that the interest rate you are getting will compensate you for the risk that he won’t pay you back). The securitization bubble happened because investors were willing to outsource that decision to other people — banks and credit rating agencies — who had different incentives from them.

What’s more, it turned out during the crisis that a lot of the investors in the securitization market were banks — specifically, they were European banks and SIVs who, in a feat of regulatory arbitrage, managed to discover that it didn’t matter how much credit you were exposed to, just so long as it carried a triple-A rating. I think we can all agree that insofar as banks are lending, they should be lending directly to borrowers, rather than outsourcing what’s meant to be their core competency to investment banks in the modeling-and-repackaging business.

The stubborn refusal of the securitization market to participate in the current credit boom is one of the few chinks of light I’m seeing these days. It shows there’s still some common sense in the world; long may it stay that way.


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