The Trojan Horse of Europe’s Capital Markets Union, part III

In addressing the proposals of the European Commission on securitised assets, the European Parliament (EP) is missing the point, argue Ewald Engelen and Anna Glasmacher. In the third part of their series of articles on FTM about this issue, they analyse the working document prepared by Dutch rapporteur Paul Tang which will serve as the basis for the EP’s debate, and address what they see as its flaws.

Today, the Committee on Economic and Monetary Affairs of the European Parliament (EP) will begin preparing its response to the proposal of the European Commission (EC) to set up a new market for ‘simple,’ ‘transparent’ and ‘standardized’ (STS) securitisations (ie. repackaged mortgage loans). The basis for the upcoming debate is a ‘working document’ prepared by the rapporteur on this issue, Mr Paul Tang, who is a member of the European Parliament for the Progressive Alliance of Socialists and Democrats.

In earlier blogs on the European Commission’s Capital Markets Union (CMU), of which this proposal is a part, we dissected the mismatch between narrative and legal text (part I) and noted that there was nothing ‘simple,’ ‘transparent’ and ‘standardized’ about the kinds of securitised assets the European Commission wants to push (part II). Our overall conclusion was that the storyline of this being about creating an extra, non-bank based credit intermediation chain to support Small and Medium Sized Enterprises (SMEs) and help ‘jobs and growth’ was false and that it was actually about a ‘significant reduction’ of capital charges for banks and hence marked a reversal of the post-crisis re-regulation of banks.


Here we take a similar approach to Mr Tang’s ‘working document’. To give the game away at the outset: it is disappointing, in that it doesn’t address the real issue, doesn’t question the real purpose of the proposal, puts too much faith in the benefits of transparency and is willing to go even further than the Commission in extending the STS label to include synthetic as well as third-country securitisations. In short, this is a timid response, which does nothing to counter the potential harm a revamped securitisation market could have for citizens and is too mindful of the concerns of large European banks. It is a missed opportunity.

The document by and large agrees with the Commission that reviving a market for securitisation in Europe is a good thing

The ‘working document’ starts with a short overview of what went wrong with securitised mortgage assets during the crisis, before drawing the main lessons from this recent episode of financial history. While doing so, Mr Tang reproduces some of the ‘mythology’ surrounding securitisation fabricated in the documents of the European Comission that we deconstructed in our earlier posts. The third sentence, for instance, reads:

If well designed, these proposals can create an incentive for more and better investment in the EU, including a transition towards a low carbon economy and more long term investment.’

This sets the tone for the rest of the document, which by and large agrees with the Commission that reviving a market for securitisation in Europe is a good thing since, at least in theory (‘if well designed’), it opens up new funding sources for banks which could, again in theory, be put to good use in the real economy, either directly (through securitising SME loans) or indirectly (through securitising mortgage loans and using the credit freefall to finance SMEs).

In our view this is at best wishful thinking, since before the crisis, as we noted in our first contribution, securitisation was almost exclusively used to resell mortgage contracts, which has nothing much to do with long term investment, let alone with financing ‘a transition towards a low carbon economy,’ but merely feeds the buying and selling of already existing assets. A few lines down, Mr Tang in effect acknowledges this when he writes that ‘securitisation is still mainly a source of finance for banks’ and hence does nothing for the stipulated aim of CMU to construct a non-bank alternative for credit intermediation that especially caters to SMEs. The key sentence here is to be found at page 14, which reads:

Even if the STS initiative helps the securitisation market to revive the impact on financing SME’s are (sic) expected to be modest.’

This is no less than two qualifiers in one sentence: ‘even if...’ suggests strong scepsis over whether the STS initiative actually would help, and ‘modest impact’ means a marginally positive effect at best. Together, these qualifiers imply: no effect at all.

This is a timid response, which does nothing to counter the potential harm a revamped securitisation market could have for citizens and is too mindful of the concerns of large European banks

Nothing but hot air

While we do agree with this sober assessment of any potential impact of a revived European securitisation market on ‘jobs and growth,’ we would consequently have expected Mr Tang to have raised the crucial question why the Commission would want to push it in the first place, if it isn’t going to deliver ‘jobs and growth’. We have looked in vain for this line of inquiry. Instead we found the non-sequitur that:

A set of clear rules for securitisation and a label for STS securitisation could support the revival of market, but only if they are carefully calibrated.’

This is nothing but hot air, stating that in an ideal world (‘if carefully calibrated,’ ‘if well designed’) all would work as intended and hence all would be well. Alas for Mr Tang, we don’t live in such a perfect world, where securitizations are ‘well designed’ and the rules are ‘carefully calibrated’.

Just as indicative of the timid nature of the ‘working document’ are the sections dealing with the lessons learned from the crisis. Mr Tang mentions no more than two: not enough transparancy and too much moral hazard — meaning that the originators were given too much opportunity to screw over their customers. This is a reductionist reading of the crisis and reflects a mainstream microeconomic perspective that is at the root of both Mr Tang’s diagnosis of what went wrong as the interventions he suggests to solve those problems. Reading his take on the origins of the crisis, it is as it were caused by nothing more than a series of interest misalignments in a chain of principal-agency linkages, and it therefore had nothing to do with ‘excessive financialisation‘ and/or ‘capitalist overaccumulation‘.

A Marxist or a Minskyan would instead have argued that these ‘problems’ were dwarfed by a third one, namely the hugely wasteful misallocation of capital that was facilitated by securitisation. As we spelled out in our earlier posts, securitisation allowed banks to sell on their repackaged mortgages to foreign investors (pension funds, asset managers, insurers, banks) and hence enabled them to tap into foreign saving surpluses to finance domestic credit provision over and above the level of domestic savings. The infamous ‘deposit funding gap’ (ie. the mismatch between household deposits and household (mortgage loans) debt was not the cause of securitisation, but its effect. Once securitisation took off in the mid 1990s, real estate bubbles were just around the corner. The outcome was predictable: disastrous increases in household indebtedness and ravaging real estate bubbles, which, according to recent econometric analysis of the Bank of International Settlemements (BIS) and others, have had long term negative consequences for the growth potential of national economies. According to the BIS, we are still in the midst of a  tenacious ‘balance sheet recession’ as a result, harming the economic interests of the young in particular. This lesson is woefully absent in Mr Tang’s ‘working document’.

Minimalist reading

If lack of transparency and moral hazards are the main lessons, Mr Tang’s solutions follow suit: a bit more skin in the game than the 5 percent the Commission is proposing to cover moral hazards, while setting up a public register for STS securitization, should address the transparency issue. Even if one accepts Mr Tang’s minimalist reading of the crisis, it is telling that the most important issue by far, addressing moral hazards, is dealt with only summarily while the more marginal concern of transparency gets most of the exposure in Mr Tang’s ‘working document’; it was also the main selling point in the press statement Mr Tang made last Friday. No less than two full paragraphs are dedicated to a detailed description of a ‘public registry’ for securitisation, which looks strikingly similar to a Dutch initiative that has also received positive press coverage in the documents linked to the Commission’s proposal, ie. the public registry of the Dutch Securitision Association.

The ‘working document’ in some sections even proposes to go beyond the Commission’s proposal

What is more is that the ‘working document’ in some sections even proposes to go beyond the Commission’s proposal. For instance, Mr Tang suggests that the STS-label should be stretched to also cover synthetic securitisations (securities whose risk and return profile mimick those of real assets but consist of credit default swaps (CDS) that reference those real assets). While the Commission merely left open the possibility of including sythetic securitisations in the (near) future, Mr Tang wants to include them straight away. Here we perceive traces of pressure by large institutional investors such as Dutch pension fund PGGM, which has recently done precisely such a deal with Santander; € 2.3 bn worth of credit risks shifted from bank to pension fund in return for a handsome insurance premium. Mr Tang is also willing to include foreign securitisations or European securitisations of foreign assets as being eligible for the STS label, arguing in classic neo-mercantilist style:

Such a restriction [of foreign securitisations] may reduce the investment flows into Europe and could cause retaliation from other jurisdictions which would not recognise EU STS securitisation as qualifying for favourable treatment under their own jurisdiction.’

Most striking, in our view, is the absence of a serious discussion of what is arguably the key aim of the Commission’s STS proposal: a ‘substantial reduction’ of capital charges for originators and buyers of securitised assets. This is addressed in the neutral language of devising the right ‘incentives’ for banks, insurers, pension funds and asset managers to use the new market niche for STS securitisations:

The success of the STS depends obviously on devising an effective incentives’ framework for banks, insurers, funds, etc. to adopt it, whether through the capital requirements for banks in the CRR amending act or through the upcoming requirements for insurers in the Commission Delegated Act under Solvency II or as part of the ongoing discussions on the Money Market Funds Regulation.’

Again, this clearly speaks to the concerns of banks and institutional investors alike that capital requirements based on the US experience with sub prime mortgages are perceived unduly restrictive, given the lack of defaults of European securitizations, and should hence be replaced by a more ‘risk sensitive’ approach, another euphemism for lower capital charges. This is choosing profitability over stability.


In our view this is a disappointing document. It doesn’t address the real issues (real estate bubbles, misallocation of capital, de-financialization), buys too much into the storyline of the Commission that a revival of the securitisation market in Europe is crucial for ‘jobs and growth’ and is even willing to extend the scope of applicability of the STS label, opening up the possibility of a full return to pre-crisis industry practices. If this is the best our European representatives can do to protect us from a Commission that is evidently co-opted by the banking sector, then nothing can save us from their excessive lobbying power any more. Eight years after what was arguably the largest financial crisis since the 1930s, democratically elected politicians are again on the verge of signing off on legislation that risks letting the profitability concerns of banks prevail over the stability concerns of citizens.