Corporate Governance

Back to Basics: Keeping Securitized Assets Transparent and Simple

By Carol Straw

Securitization will survive the current market crisis, according to Jim Hamilton, who reported on the remarks  of Adair Turner, the new chair of the UK Financial Services at the International Banking Seminar in Washington. However, banks must return back to the original idea of securitizing assets on bank sheets for sale to investors in transparent simple instruments held to maturity. In Turner?s view, the original reason for securitization remains valid, namely taking accumulating credit assets off bank balance sheets and distributing them directly to end investors who can select desired risk return combinations and thereby reduce the concentration of risks on particular intermediary balance sheets. A return to on-balance sheet lending is probably not in the cards.

Turner shared that securitization morphed into something much more complex, opaque and risky. Securities were packaged by tranches. Derivatives were used to hedge risks, with huge unsettled counterparty exposures. Contrary to its' original intent, a large proportion of the securities were not in fact passed through to end hold-to-maturity investors but held and traded on the balance sheets of banks and on the off balance sheets of banks through conduits and in the highly leveraged balance sheets of investment banks.

He emphasized that the regulatory bodies must now demand more capital in financial intermediation, both via higher capital requirements for banks and more effective steps to prevent highly leveraged shadow banking entities such as conduits, escaping capital regimes. Any reform that augments currently lacking regulatory oversight and keeps investors well informed about the risks associated with these kinds of instruments is welcomed.

See Jim Hamilton's blog @ 10/13/2008 04:58:00 PM

Full post as published by PomTalk on October 17, 2008 (boomark / email).