Large portions of these markets have remained unavailable for new business due to the hundreds of billions of losses on securities backed by subprime mortgages and the ongoing widespread uncertainty about how much complicated instruments backed by loans are truly worth.
Even though many areas of the financial markets have resumed a regular pace of activity, with businesses raising record sums in the bond markets this year and initial public offerings in stocks picking up too, activity in the markets for securities backed by loans, particularly in the US, is still only a small portion of what it was before the crisis. This is where securitization comes into play. Let’s take a look at the steps on how to restore investor confidence in securitization in detail.
What exactly is securitization?
Securitization, a strategy of raising capital that enables banks to remove loans off their balance sheets, including mortgages, by grouping them together and selling securities guaranteed by the payments on those loans, has been used to generate more than $6,000 billion in the global economy.
The decline of many of these markets continues to limit credit availability, which has an impact on economic expansion. In a recent study, the International Monetary Fund said that “restarting securitization markets, notably in the US, is important to reducing the real sector repercussions from the credit crisis.” The Bank for International Settlements and the Group of 20 shared their opinions.
According to Darrell Wheeler, director of securitized research at Citigroup, “the key role securitization plays and should continue to play is very much recognized, contrary to the general impression that one of the primary lessons of the crisis is that securitized products should be laid to rest.”
The depth of the issues in these markets is shown by Mary Schapiro’s request this week for new rules to safeguard investors purchasing asset-backed securities. The Securities and Exchange Commission is the primary market regulator in the US. It also suggests that restoring their functionality will take time since adopting new laws in the US takes time.
How to restore investor confidence with securitization
According to Paul Forrester, partner at Mayer Brown, “there are still numerous concerns that need to be analyzed and understood concerning the role of asset-backed securities in the financial crisis.” Not only were legislative modifications necessary, but many of them also had to be applied globally, which increased the level of complexity. In light of the fact that many of the securities whose value fell held top, triple-A ratings, one of the key concerns is fixing the flaws discovered in credit ratings for asset-backed transactions.
Additionally, efforts are being made to provide investors with sufficient data in a standardized manner so they may do their own analyses without the aid of credit rating organizations. Other concerns include changes to how regulators handle capital regulations globally and the need for uniform accounting standards.
The US Treasury and Federal Reserve have revived the markets that support consumer loans by enticing investors to purchase securities backed by loans.
In order for investors like hedge funds to purchase securities backed by credit cards, auto loans, and other types of lending, the Fed has granted them $50 billion. Although significantly below the peak, volumes are expected to be greater than in 2008 this year. Compared to $140 billion in 2008 and $750 billion in 2006, the American Securitization Forum anticipates US asset-backed securities (excluding mortgages) to reach $130 billion in 2009.
Parts of the US markets that are used by real estate developers to fund new transactions, such those for commercial mortgage-backed securities, are still mostly closed. In fact, the Fed intervened by purchasing assets backed by home mortgages for close to $1 billion.
Additional measures to boost confidence
To restore trust and confidence, four modifications need to be implemented. They would provide a strong basis for the sector and aid in the recovery of our faltering economy.
First, “orderly financial markets” must be restored and maintained. ICMA noted that deregulation, which enabled different financial services business sectors to invade one another’s domains, contributed to this issue for decades. As one of many instances in which businesses play dual roles, this has made it possible for investment banks to own commercial banks and issue financial instruments that are insured by the Federal Deposit Insurance Corp. in order to raise money that is ultimately used to finance inappropriately aggressive investments.
Over a number of years, the inability of Congress, numerous administrations, governments, and self-regulatory bodies to control the production of securities derivatives and the interaction between various financial services industry sectors has been cited as a contributing factor to the crisis.
It is vital to re-regulate the financial services sector, maybe by reinstating the Glass-Steagall Act, which distinguished commercial banks from other investing activities. To keep securities, banking, and insurance/annuity products apart from one another and from any other inventions that would obscure their separation, similar regulation is essential.
Further securities industry regulation should distinguish between the fee-based investment counseling role and the investment banking function, and anybody authorized to provide advice for a fee would not be permitted to sell securities for a commission.
Final words
As a result, in our society, we were able to accelerate the growth of our economy. And throughout the 1990s and into the present decade, it became abundantly clear that excellent asset creators produced loan assets of all kinds in excess of what they could safely maintain on their own balance sheets. Through the securitization process, they took these assets and produced highly appealing investments for pension funds and other kinds of institutional investors. We ultimately came to the conclusion that securitization was a technique that effectively enabled cash to flow from end investors back to debtors who really needed the money. Additionally, the securitization process as a tool functioned admirably in many instances for a significant portion of this period and disastrously when it was misused.