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Asset-backed securities precipitated the crash: let’s do it again!

It is almost unbelievable, but true, that at the highest levels of today’s capitalism it is being proposed that the asset-backed securities which provoked the banking crash in the first place should now be relaunched as the best avenue for recovery. Both Draghi, president of the European Central Bank, and Carney, governor of the Bank of England as well as chair of the Financial Stability Board, have given their support in the last few days to a resumption of securitisation. The latter may have an arcane name, but the idea is clear enough.

The banks, instead of waiting 25-30 years to get their money back on a mortgage loan, transform what is an illiquid asset (property) into a liquid asset by pooling them and slicing them into smaller securities that are then sold for immediate cash to investors. It’s being argued that that’s not only good for banks by enabling them to lend more (and thus make more profit) and to reduce their exposure to risk, it also (it is said) raises economic growth by increasing overall investment. This is a schoolboy howler: it may accelerate the financial merry-go-round of exotic financial derivatives, but it certainly won’t increase investment in real things.

There are two other aspects of this which really stand out. First, it is an incredibly risky manoeuvre. It will be said of course that the lessons of the 2008-9 crash have been learnt so that these proposed new securitised assets are much safer. It is however worth looking closely at the grounds on which these claims are being made. It is said that’incentives are now better aligned’ by making those selling these securities retain a part of the risk. But how big a part, and will it really stop that part being parked offshore beyond the UK jurisdiction or sold on by some form of regulatory arbitrage?

It is said there will be greater transparency to improve investor awareness of the underlying assets. But how will that work when most investors are so anxious to trade up their profits that they never read closely what’s written on the tin. And it is said there will be measures to stop banks off-loading low-quality lending. Really? After the experience of banks in the last decade, it’s surely naive to expect that will work.

But, second, the really big objection to this really barmy proposal is that it’s hugely dangerous. The last time round they nearly brought down the global economy. Does it make any sense at all to re-deploy such mechanisms even if this time around their riskiness has been marginally reduced? So why are they doing it? That’s the most interesting question of all. It is incredible that for ideological reasons they are so obsessed with using monetary mechanisms exclusively that they won”t even consider any fiscal relaxation (e.g. using public investment to generate expansion and job creation) to spark growth even though that’s obviously the right answer.

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