Another Brick in the WallWhat struck me was the picture of what I think is Hadrian's Wall (2nd century AD) with the slogan "We can withstand the test of time". True enough: the wall is still there, but as a historical curiosity rather than serving any useful purpose.
You wonder what gets into these ad agency types when they come up with such stuff. I recall Microsoft using the Rolling Stones' "Start Me Up" for the launch of Windows 95. The bit Microsoft omitted to play in the ad was the chorus, which would have been very appropriate for this horrible software, "You make a grown man cry..."
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The European Securitisation Forum (ESF) published its updated market report today. There are some interesting points in there:
-Total European issuance in 2008 was EUR 711bn. The highest ever: 57% higher than 2007! This brings outstandings to a huge EUR 1.74trn.
-CDOs were down EUR40bn at 48bn, ABS was up EUR 25bn at 73bn.
-But the winner is RMBS, up a massive EUR325bn at an even more massive 585bn. Just about all of which is either retained by the banks, or posted as collateral with the central banks.
-The US market, on the other hand, fell from USD 2.15trn in 2007 to 0.93 trn in 2008.
-The biggest increase in issuance was in the UK, where nearly EUR100bn more was issued in 2008 than 2007
-Auto and credit card still show remarkable rating stability
Conclusions:
-There is still plenty of structuring going on
-Outstandings continue to grow-securitisation is playing an important role in getting liquidity to banks
-There are still excellent opportunities to buy good assets at very high yields. Contrarian investors in the mould of Warren Buffett and Sir John Templeton could do very well
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There are some good soundbites in the FT at the moment. One writer says "Investment banks and hedge funds turned financial risk into financial crack with leverage." Leverage was, of course, one of the chief culprits of the 1929 crash too. Lex writes "Bankers, mourning their slashed bonuses, offer up prayers never to hear the words “residential mortgage-backed security (RMBS)” again." These comments represent two recurrent themes: "We should have seen it coming"; and "Securitisation bad".
To deal with the first one, perhaps we should have seen it coming. I have checked my files, and my first use of the phrase "too good to be true" in writing was on 27th April 2007, in the context of the dreaded CPDOs. I also got some stick when addressing a non-conforming mortgage conference in December 2006 for some slides suggesting that a bubble was a reasonable analysis. But this was like the shadows in Plato's cave-at no point did I predict what has occurred; it was just an inkling that something was not right. Most had no inkling, and the very few who called it right were Cassandras-doomed to be both right and not believed.
On the second point, it concerns me that so many people are rubbishing risk distribution. It is, nonetheless, a fundamentally sensible approach. Banks have been doing it for centuries: Bank A has a large customer and cannot prudently lend more, so sells or sub-participates some of the risk to Bank B. Everyone benefits. The moral hazard is that Bank A originates a bad loan and flogs it off whilst trousering a fat fee. That needs to be controlled, but banning risk transfer would make for a very inefficient financial system: banks would have risk concentrations, and investors would have a poor selection of low-yielding investment opportunities. That's our pensions suffering, amongst other things.
A recent research piece by Barclays stress tests RMBS to a "severe" standard, including a further 30% fall in house prices from Sep 2008, which they describe as being beyond AAA. None of the 61 AAA tranches in the UK, nor the 16 in Ireland, suffered a loss under this scenario. Yet these bonds can be bought at a yield of 3-400bp. A prudent re-opening of this market would help the housing market by getting money to housebuyers, with a knock-on effect on confidence.
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“Who shall guard these guardians?" Rating agencies, that is. They’ve had a rough time, poor fellows: pilloried for giving high ratings on billions of structured notes based on defective models (one agency is alleged to have discovered fundamental flaws in one model and covered it up for a year!); accused of incompetence and huge conflicts of interest; suffering calls for their regulation before they can do any more damage...who has any belief in rating agencies any more?
Lots of people, it seems. It is confusing to read in the same papers which have been rubbishing raters the shock horror suggestion that the UK might lose its AAA, er, rating. Either you believe in ratings or you don’t, one would have thought.
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The anglo-saxon mentality loves property. But there have been several spectacular busts, from the secondary banking crisis in the mid-70s, through the crash of the early 90s to the latest manifestation of “this time it’s different” (it wasn’t, of course) in more recent times.
Why is this? My own view is that we’re in the realms of psychology: houses and other buildings are literally tangible, and give a feeling of solidity and security. But buildings are also illiquid in all senses of the word. The weaknesses of property as a banking asset are that it is long term; and produces little cash flow (i.e. relies on a sale or refinancing). My proposal is that lending against cashflow assets rather than property is more solid, and more likely to be “fit for purpose” in the current environment.
Let’s assume two banks lending to an SME. Bank A has a term loan secured on the company’s buildings. Bank B provides money via factoring/trade receivables financing or similar, in other words against the SME’s trade debtors. Which is preferable?
Experience has shown that firms, in this case the SME’s debtors, will pay their suppliers first, otherwise they might be out of business fairly quickly. After this, if the SME is having trouble paying the bank loan, the directors would approach the bank with a re-scheduling proposal. Any sensible bank (although some would say that that is an oxymoron these days!) does not want to crystallise a loss, plus the hassle of enforcement, sale of a property into a falling market and bankruptcy of the SME if it thinks that it can get paid over time.
Lending backed by property is superficially seductive, but lending backed by shorter-term assets such as trade debtors is more solid. This is illustrated to some extent in the world of securitisation: as far as I have been able to ascertain, no trade receivables bond has ever been downgraded except due to counterparty risk, such as downgrade of a swap provider. The same cannot, unfortunately, be said for property-backed bonds.
The conclusion is that we need to monetise shorter-term assets such as trade receivables and trade finance receivables. This will get money to firms which desperately need it; and give investors a high-quality and stable asset.
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