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This is the first part of a three-part series on the regulation of securitization before and after the crisis. Why were the banks so affected by the run on the shadow banking sector, which was formally off-balance sheet? How can we explain the lack of regulation in the shadow banking sector? How did governments promote the expansion of the credit supply via the shadow banking system?
Securitization has had a very bad press reputation in recent years (but see “securitization is not that evil after all”), being related to overly complex re-securitizations, which became impossible to value during the financial crisis of 2007/2008. Before that crisis, securitization was en vogue, favored by most financial economists as a way to spread credit risk from banks into the financial markets, thereby increasing the resilience of the financial system as a whole (s. Bhattacharya et al 1997). The idea was to liquefy credits, to turn them into tradable assets, generating deep secondary markets in which traders could constantly readjust the amount of risk they held in their portfolio. Banks could refinance the credits they gave and thereby expand their lending. Credit would become cheaper, as the demand for securitized assets generated from credit increased, raising the available supply of credit.
Turning credits into tradable assets requires that the transfer of these assets into money is possible instantaneously and without loss of value. Otherwise, the entire idea of readjusting one’s portfolio to changing market circumstances; which is what underlies modern portfolio theory (also the Black-Scholes formula requires continuous adjustment of the traders position, which is why trading in continuous time is a necessary assumption for the pricing to work). Credits on banking books, in contrast, are held on the book of the banook at historical cost accounting (s. Sigrids work on fair value accounting); i.e. not changing their value from the contracted valuethe moment the contract is signed. Only if banks undertake corrections in value to account for expected losses does the value of these credits in the books of the bank change.
In this blog I will look at the infrastructural preconditions of securitization (Special purpose entities, in the following SPEs) and the shifts in how they were proposed to be treated at an international level and how they were treated on a national level before the crisis and after the crisis. Before the crisis, there was pressure by the Committee of European Banking Supervisors to not force these SPEs on the balance sheet of banking groups (CEBS 2004). After the crisis, we can witness a 180° shift in the position of the financial stability board which states that it wants full prudential consolidation for sponsored SPEs. In my three blog entries I will have look at the impact these transnational recommendations had before the crisis on actions of national governments and will speculate about the fate of the current regulatory proposals in the future. Read the rest of this entry »
The last few weeks have seen a number of news stories indicating that the broad agreement reached by the G20 in early 2009 regarding the regulation of Over the Counter (OTC) derivatives is breaking down. On January 5th 2010, for example, the Financial Times titled ‘Cracks in transatlantic derivatives rules‘. In the UK, the Financial Services Authority and the Treasury published in December 2009, a report on regulation of these marketswhich, whilst couched in supportive language, made a number of criticisms of the Commission of the European Communities document on this topic published in October 2009 .
Meanwhile in the US, the US Treasury is aiming to achieve legislation on this topic; in Congress, the House has agreed a draft bill which differs again in some respects from both the UK and the EU and the Senate is due to consider the issue this month. Most recently, non-financial companies in the EU under the aegis of the European Association of Corporate Treasurers have protested strongly about some of the existing proposals in a letter addressed to the EU Commission on the grounds that they will financially penalize them .
The result is a somewhat confusing situation in which the danger is that regulation will not be coherent across the main financial markets and regulatory arbitrage will emerge, potentially paving the way for a further destabilisation of the global economy. Many of these debates and differences appear very technical but as I have sought to show in a recent article on ‘Legitimacy in financial markets: credit default swaps in the current crisis’ in Socio-Economic Review, underlying them are major issues of politics and power.
In 2009, many received wisdoms of late capitalism are crumbling. To mention a few disappointments, which it didn’t take a telescope to see from a mile away,
- No – we haven’t overcome the business cycle.
- Sorry – China and India aren’t gonna drag us out of the recession.
- Nope – deregulation doesn’t bring widespread prosperity.
- Too bad – wealth doesn’t grow on trees or in banks or hedge funds.
- Please – add your own favourite here: __________________________
A crisis is a moment in which illusions or expectations fall apart. In the Nigerian novel “Things Fall Apart”, the patriarchal protagonist Okonkwo confronts a world of changing values (colonialism, Christianity) in which he finds he has no leading role left to play. Rather than adapt to these circumstances, he takes his life.
This pessimistic example, however, doesn’t seem to apply to some international organisations in the current crisis. Rather, after years of seeming anachronistic, the World Bank, IMF, NATO and OECD are experiencing something of a revival – notable absentee: the UN.
According to classical (or vulgar?) institutional theory, institutions persist rather statically until some kind of “critical juncture” suddenly occurs, at which point they disappear or reinvent themselves (or are reinvented). As far as critical junctures go, they don’t get much bigger than the 2007 to 20xx? global capitalist crisis. Read the rest of this entry »