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This is the second part of a three-part series on the regulation of securitization before and after the crisis. This part’s topic: The states’ helping hand: finance ministries and the expansion of securitization in the EU.

As I explained in part 1 of this series, securitization required the transfer of credits from banks’ banking books into shell companies, where the cash flows from these credits would be redirected to serve debt instruments that the shell company (or Special-Purpose Entity, SPE) emitted. The banks remained linked to the revenues and risks of these assets by providing liquidity lines to these shell companies in case the market fell dry.

When the crisis in the subprime mortgage market became evident, the buyers of debt instruments emitted by SPEs which had assets on the asset side whose cash flow was seen as deteriorating. Buyers in the market refused to take up the risk, as they could not price it and feared to have to take losses. In this moment, the liquidity lines of banks were drawn, and banks bought the papers from the SPEs they had initially set-up to get rid of these assets.

Now that they ended up refinancing the assets they had sold to the SPE, they in fact became again the owner of these assets, which is why they reappeared on their balance sheets, but only in the worst of moments. The first SPEs which experienced such a buyers strike were those which did not even have a liquidity line and where the buyers were supposed to carry the entire credit risk themselves. Rather than imposing losses on their clients, many banks took the assets they had transferred into the balance sheets of these SPEs (called Structured Investment Vehicles) back on their own books for reputational reasons. Banks argued that they could better cope with the deteriorating value of these assets by holding them to maturity and that imposing losses on their clients would endanger their future financing possibilities.

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