Today European Commissioner Jonathan Hill presented his long awaited action plan for the creation of a Europe-wide Capital Markets Union in Brussels. A key plank of this Union is the attempt to resuscitate the market for securitized mortgage loans, which, due to its role in igniting the financial crisis, has been moribund since the outbreak of the crisis. The aim of the Commission is to create a new market for safe securitizations based on simple, transparent and standardized products. In the article below Ewald Engelen and Anna Glasmacher, both from the University of Amsterdam, critically discuss a draft proposal to that effect, that they have obtained through wikileaks. The authors argue that the proposal is based on faulty assumptions, is dangerous in that it furthers financialization and that it hence should be stopped.
Funding tool for banksThe surprising thing to note is that since the launch of the CMU, the Commission has redirected its efforts mainly at the securitization part of the proposal, which appears only at page 11 of the Green Paper and is formally not about constructing an alternative credit intermediation channel to bank finance anyway but serves mainly as funding tool for banks and as such only reinforces the dependence on bank finance. In other words, securitisation helps banks to find alternative sources of funding but is not in and of itself an alternative to bank lending. Nevertheless, the ‘public’ consultation on this part of the CMU has already finished, has been worked into a revised proposal by the European Commission and can now be downloaded from wikileaks as a draft legislative proposal, including an explanatory Memorandum laying out the rationale behind the draft. The aim is to get it through European Parliament as quickly as possible in order to be able put it in force as of the first of January, 2016, which, we surmise has everything to do with the need to refinance existing securitisation which, in general, have a maturity of five to seven years.
The aim is to get it through European Parliament as quickly as possibleThe document we discuss below is revealing in that it betrays the major extent to which the thinking of the European Commission has been infected by the interests of banks and as such bodes ill for the willingness of the Commission to keep momentum in its reregulatory effort after what was arguably the biggest financial crisis since the 1930s. Below we critically discuss a number of key passages of the Memorandum preceding the draft proposal to demonstrate that. We do so by first looking at ‘Claims’, then at ‘Aims’, and, third, at ‘Means’. Under the heading ‘True aims’ we finally say something about the extent to which the Commission has been ‘captured’ by the banking industry.
Claims: feeding the real economy
Empirics actually suggest Ponzi-like financial instabilitySimilarly, the memorandum talks of securitization... ‘providing banks with a tool for transferring risk off their balance sheets (...) and free up more capital that can then be used to grant new credit including SMEs’ (p. 11). Again, it is hard to take those claims seriously after a crisis that clearly demonstrated that, despite endless assurances from bankers, regulators and financial economists that securitization has dispersed risk among a much wider array of financial institutes and had thus made the overall financial system more robust, risks were instead highly concentrated raising the issue of banks being too-interconnected-to-fail. Seven years after the crisis one would have expected any proposal to again allow banks to transfer risks from their balance sheet to at least demonstrate why this time it is different and how the issue of interconnectivity is solved. Nothing of the sort is to be found here. Further to the unsubstantiated claims made for securitization in the memorandum is the expectation that standardization would reduce ‘operational costs’ for the buyers and sellers of securitization, which ‘should have an especially beneficial effect on the costs of credit to SME’s.’ This too beggars belief because even when one accepts that standardization would lead to lower operational costs on the side of the securitizer (standardization would lead to a less complex and hence more industrialized and cheaper securitization machine) as well as that of the ultimate buyer (standardization, simplicity and transparency would diminish search and assessment costs), it doesn’t follow that these cost gains work their way through to the ultimate borrower. Banks have proven to be well able to pocket those sorts of gains themselves instead of passing them on to customers. In other words, without more invasive legislation in place to force banks to do so this is mere wishful thinking.
Aims: removing stigmas
Banks again have succeeded outsourcing their credit risks to the taxpayerActually, the difference between the US and the EU in terms of defaults on home mortgages, because that is what we are dealing with here, can be explained by legal difference between mortgage loans in the US and the EU. Whereas in the EU all mortgage loans are full recourse loans, meaning that the contract gives the creditor full legal protection against payment shortfalls, in the US most mortgage contracts are non-recourse contracts, meaning that the owner-occupier can simply walk away from his mortgage obligations, resulting in a factual default and a quick decrease in value of the mortgage security in question if the scale of default is widespread enough. As it apparently was in 2007, 2008. Add a higher level of livelihood protection in the EU through a more inclusive and more generous welfare state, and the picture that arises is one where banks again have succeeded outsourcing their credit risks to the taxpayer in the form of the court system and the welfare state. Moreover, claiming success for European securitizations is committing the fallacy of composition. That individual European securitizations upheld their value throughout the crisis is not to say that securitization as such did not severely harm the long term interests of households, SMEs and national economies. The real estate bubbles it helped create in countries like Ireland, Spain and the Netherlands have, when they came undone on the backdrop of the credit crunch caused by widespread distrust in interbank markets due to the bankruptcy of Lehman Brothers, forced a substantial proportion of Dutch, Irish and Spanish households to cut back on consumer spending to contain the increasing discrepancies between the nominal value of their mortgage and the market value of their collateral. Together with misperceived and mistimed austerity policies, this has unnecessarily extended the recession and has substantially hurt the long term earning capacities of citizens and economies alike. It beggars belief that a mere seven years after the crisis, an official document of the European Commission would fail to perceive the huge externalities of housing booms and busts sharpened by widespread securitization and would willingly reproduce the industry-meme that there never was anything wrong with European securitizations. Worse, would even attempt to roll out securitizations to member states which have up until now succeeded in avoiding such a fate. From an individual investors perspective the claim that securitization is safe may well be true, but from a citizens’ perspective it definitely is not.
Means: creating a new market
The STS definitions give huge leeway for banks to provide their own, minimalist interpretationsOverall, the STS definitions only exclude the worst tricks (hidden ‘reverse seniority’-clauses) and excesses (‘refilling’ RMBSs with worse MBLs) from before the crisis, whereas the information requirements for sellers are overly lenient and give huge leeway for banks to provide their own, minimalist interpretations. Most of the € 1700 billion worth of European securitizations from before the crisis would easily have scaled this threshold.
True aim: lowering capital charges
This is equal to the pope blessing a weapon of mass destructionThe Memorandum briefly summarizes the outcomes of the public consultations on page 10, where it is, more adequately, referred to as ‘stakeholder consultation’. The text spells out that the Commission received 120 replies that indicated ‘that the priority should be to develop an EU-wide framework for simple, transparent and standardized securitisations’, based on the recognition that EU securitization have held up their value in the crisis and should hence, according to the key financial principle of ‘risk sensitivity’, be treated more lenient than US ones, both by regulators and by end investors. This, thus the Commission in its own summary of the stakeholder replies, apparently glossing over the critical replies by NGOs such as Finance Watch and Progressive Economy: ‘would help the recovery of the European securitisation market in a sustainable way providing an additional channel of financing for the EU economy [read: real estate] while ensuring financial stability' (p. 10). And if the similarities between the phrases summarized here and the ones used earlier by the Commission itself are not a sufficient giveaway for who is truly behind this initiative, data from Eurosurvey give the game away: 110 of the 120 repliers came from the industry itself, with an overrepresentation of British and Belgium-based organizations; the latter, of course, indicating the overrepresentation of the Brussels-based financial lobby. The Memorandum nicely continues with the following sentence: ‘On most issues the input from stakeholders was fully taken into account’ [our underlining] (p. 10). Not mostly, but fully. While under the heading ‘Collection and Use of Expertise’ it is stressed that: ‘Fruitful meetings and exchange of ideas with private sector representatives […] have enriched the debate and understanding of the issues at stake’ (pp. 10-11) To conclude: Hills CMU is a Trojan horse for the interests of a banking sector that is beyond control. For proofs go to the website of the AFME and have a look at their Annual Report, which so much as claims that they have booked a complete victory over their adversaries on the CMU and securitisation: ‘Since June 2015, we have undertaken an outreach program to meet with key policymakers and opinion formers on CMU – including Commission officials, finance ministries and central banks, MEPs and think-tanks. […] We will continue to be active and closely engaged across the CMU agenda, including in areas such as infrastructure, securitisation and SME funding, which are vital to promoting growth. In December 2015, together with Euromoney and ICMA, we will hold a conference in Brussels on CMU. Commissioner Hill is confirmed as keynote speaker, and this event should provide the opportunity for the industry to respond in detail to the Commission’s action plan’ (p. 4).
Hills CMU is a Trojan horse for the interests of a banking sector that is beyond controlOr what to make of the digital announcement of a so-called CMU breakfast in Brussels on the 1st of October, 2015, where the main figurehead of the financial services industry in the European Commission, Commissioner and former lobbyist for the City, Jonathan Hill, was to field questions from financial insiders. The main sponsor? Managed Funds Association: ‘the voice of the global alternative investment industry’, i.e. a lobby organisation for hedge funds. We urgently call upon the members of the European Parliament to stop this attempt to resuscitate securitization markets and further the financialization of Europe. This does not serve citizens through job growth and sustainable economic growth but merely feeds asset inflation, real estate bubbles and bankers’ bonuses. In our opinion, this is not the constituency the European Commission should placate.
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