Securitisation is innocent

This blogger recommends that you zip over to Delusional Economics and read Deep T. on securitisation.

The piece is detailed and this blogger won't go into the technicals of it. The point it wishes to make is not technical anyway, it's philosophical. Deep T. begins:

The 60’s were a time of great change in attitudes to what’s important in life, even in the suburb at the edge of town where I grew up. The variety and conflicting attitudes of those that surrounded me were inspirational in making me think about what was important and meaningful as no one seemed to articulate very well about how the world works for them but plenty were asking questions.

Except that is, the few, who left no doubt in my mind about which side of the progressive argument they sat. This included my dearly departed high school principal who when berating me about the length of my hair and when I quite reasonably asked “What is wrong with long hair?, he without hesitation replied, “Nothing son, it’s the element that wears it!”.

In the well meaning mind of Mr Perkins, it was very clear that long hair on boys was the spawn of the devil. Unfortunately for me at the time, I had a different view and received 6 of the best, but still remained part of the “element” for a very long time.

History demonstrates whose world view was a little more balanced but these dichotomies between generations and tribes abound whenever our traditional world view is challenged. Of course hair is a thing which doesn’t create character and securitization is a thing, a tool, which does not create exploitation of the masses through irresponsible lending.

Deep T. goes on to argue where securitisation process went wrong in the last cycle.

To this blogger, this looks like a version of the old argument "guns don't kill people, people kill people". Which is entirely true. Except for one point.

Guns and people put together kill people.

So far as this blogger can tell, it's the same with securitisation.

As a process it's ingenious. Far more efficient than traditional banking. As Deep T. says, an incredibly effective way to deploy capital. That's the problem.

Add people to this equation, with all of their foibles, irrationalities and drives and you have a credit creation mechanism that is out of control. It's like handing the keys of a Ferrari to an 18 year old boy. He may drive safely, then again, he may not.

That may sound silly but consider. It has taken hundreds of years and many, many banking crises to figure out a semi stable system for credit creation. It's the compulsory and monitored reserving mechanisms captured in prudential regulators and reserve banks. Those structures bring stability to banking not through some technical quirk of banking but because they control people. They force responsibility onto credit creation through controls on how much money people can create and how well backstopped that creation is.

That is not to say that that fractional reserve banking is a perfect system either. It too is made of people and they make mistakes and abuse the system. But it is transparent and simple enough to be monitored and maintained.

Securitisation on the other hand is not. It is a credit creation chain in which each of the specialised components that make up creation of a loan - credit analysis, servicing, documentation, liability management etc - all become separate.

Doing so creates marvelous efficiencies but it clouds transparency and responsibility. The system relies upon a diffused chain of individual responsibilities in the originator, the insurer, the rating agency, the servicer, the seller and the investor - with much greater scope for abuse than narrow banking.

Sadly, if you apply the regulations that ensure responsibility, like capital adequacy, the efficiencies are lost. You can guarantee critical weaknesses in the credit creation chain, which is what is being currently contemplated in Canberra. But then of course you have moral hazard.

This blogger is quite happy for securitisation to work on the margins but it should be kept out of mass market credit creation where failures of responsibility can bring down the system.