Recent articles in the UK press have noted how asset securitisations (ABS)including those based on mortgage debt (underling loan assets)have held up well in terms of yields despite the fall since 2007 in their market prices. The suggestion is that banks need to refinance and issuing new securitisations are the obvious solution (selling to ivestors instead of heavily discounted by 'haircuts' to central banks). The problem this solution faces is how to restore market confidence in this asset class. It can only be done by better information - more transparancy - on reliability of the yields (investment income returns) in the hope that confidence in capital values will follow?The shock to the ABS market in 2007 was the 'discovery' that asset value (secondary market liquidity & prices) could divorce from yield value. Most commentators assumed that large haircuts and fall in ABS prices were a reflection of the opaque complexity of the structures and on deteriorating risk (rising defaults) of the underlying. It would have been more astute to recognise the problem of how ABS purchases were financed (using prime market deposits and other short term borrowings). The ABS confidence collapse was triggered by margin calls and distressed sales, notably Bear Stearns, Citicorp and then many others.
There was never a liquid transparant secondary market for ABS (and none previously tested over a whole credit cycle).
The markets still struggle to know market prices and try to determine these as global prices. Their default when they fail at this has to be to rely on ratings agencies ( essentially weighted score card models). In all the media and even analysts' commentary the emphasis has been exclusively on volume of ABS issuance and not on the yields and how they persisted through the crisis. This is where the complexity of ths structures did have a most damaging effect by simply making it very difficult to tell the story graphically of ABS yields. These need to be visually expressed but have to distinguish between tranches and underlying assets and even countries of origin of the underlying. No charts and graphics can be found in all of the media coverage since 2007 to show this!
But, as we should all know, the first generation ratings engines of Moody's and then S&P and Fitch were fundamentally flawed by being indifferent to default rates. When Moody's introduced a new model (a debugged version now sensitive to default rates) every week from July 2007 onwards ABS issues were re-rated, dropping as much as 17 notches in some cases. The creditworthiness of bank debt tumbled reslting in failures to refinance banks' funding gaps so as to maintain banks' business models.
This Chinese water torture on the market blew the credibiility of ABS ratings even though investors were stuck with continuing to rely on them (by regulatory laws) and asset values veered sharply away from yield values. Banks's share prices were easily shorted as they inevitably fell - because banks refused to pay the higher funding gap refinance costs.
Many major banks would have saved themselves many times those costs had they accepted borrowing at the higher wholesale rates but could not break from their past business model margins, especially those whose refinancing was an aggressively large portion of their balance sheet. Banks who had to refinance funding gaps (gap between deposits and loans) in the ehat of the Credit Crunch were nailed to a cross and looked potentially insolvent. They were lambs to the slaughter for the shorting speculators. Arguably there was no speculation involved for about 18 minths because shorting these bank stocks was a sure-fired profit winner egregiously helped by irresponsible stock lenders. Insurance (double-default risks) lost credibility fast as did too the providers of standby liquidity to SIV structures (though less known to public information) except spectacularly AIG among insurers and the "we are not directly invested in securitisations" Lloyds Bank as a very major liquidity provider (on both sides of the Atlantic) to SIVs.
It is true that ABS seen to have been the problem also has to furnish the solution. We see several cases of 'bad banks' and other ABS work-outs proving to be very profitable. ABS yields continue to be very high relative to the ratings they had in the past and even now. The problem continues however to be the amount of borrowed money versus 'own capital' and client funds used to buy the instruments and these borrowing remain suject to excessive margin calls on collateral underpinning the borrowings that were also often ABS whose market prices collapsed.
It is correct to say we require far more transparancy on securitisation issues yield performance. The overhang on that in Europe is however recession and fears of double-dip in USA and UK however exaggerated the latter really is.
If other economies turn down (e.g. in Asia) one fear is securitisations being again dumped on an illiquid secondary market!
