Securitization - A critical assessment in the light of the financial crisis

Milena Marinova

Doctoral thesis

Anotácia:

My dissertation thesis provides a comprehensive analysis of the principles of securitization techniques, of their attendant shortcomings, their regulatory treatment and the recent proposals for reducing complexity in accounting standards with relevance for securitizations. The explosion of securitization and related innovative credit risk transfer products largely expanded the magnitude and diversity of issuers, investors and securities. With this expansion numerous market participants began to wrongly believe that risk was not only shared more widely, but also that it disappeared from the system altogether. The application, or to be more precise, the misapplication of securitization in the mortgage market had fatal consequences for the financial sector worldwide. Before securitization, sub-prime mortgage lenders retained the loans that they originated on their balance sheets and therefore cared about their credit quality. Securitization techniques and related innovative financial instruments enabled the export of sub-prime mortgage structural problems from the United States globe-wide via the financial intermediaries. More over, securitization techniques and related credit risk transfer products enabled single banks to reduce their individual risk while at the same time transferred new and greater risks to the financial system. Meanwhile a lot was written on the causes for the recent financial crisis. In most cases inadequate ratings provided by the credit rating agencies and different principal agent problems were addressed. I present both for completeness in my work. However, I argue that not only the credit rating agencies are to blame for the inadequate reflection of securitization and related financial innovations and subsequently for the financial turmoil. The international and national financial supervisors in fact supported the credit rating agencies to further establish their businesses. What turned obvious during and after the financial turmoil started mid-2007 is that financial regulation failed to reach its main goal - ensuring stability of the financial system. It failed despite of the "regulatory achievements within Basel II" elaborated over the past ten years. In particular, securitization and related credit risk transfer products were not adequately treated in Basel II. Securitization-related products such as Credit Derivatives on Securitization Underlyings and numerous other complex financial innovations, as presented in my thesis, were not even thought of in Basel II. In fact, Basel II turned to do little to make the financial system more resilient. The need for further revisions in banking regulation is currently more than obvious. Furthermore, it is time to ask if the developments in Basel II are the right way to address the current risks within the financial system and hence if Basel II is the right way of banking regulation and supervision altogether. With the development of both Basel Accords (Basel I and Basel II) capital ratios became the center of banking regulation. However, capital ratios are obviously not sufficient as a measure for a systemic financial stability. These questions arise at least when financial stability and soundness are still the intended objectives and believed to be ensured through Basel II. My merits in this dissertation work root in the multi-facet analysis of securitization techniques that I provide. Up to date a comparable analysis of securitization techniques which addresses the wide spectrum of securitizations' issues - such as (i) their treatment and the related attendant flaws within the regulatory framework Basel II, (ii) the various microeconomic deficiencies related to securitizations, and (iii) the implicit macroeconomic threads of exporting credit risk and de-balancing financial stability through securitization techniques - has not been provided in the comprehensive way I built up my analysis. As a basis for my analysis, I provide a new classification of the charact

Anotácia:

eristics of securitization techniques which were pre-crisis wrongly perceived as benefits. I analyze the reasons for the turmoil in the financial markets in their interplay and complexity and consider securitization techniques as a key driver for the financial crisis. I comprehensively criticize the current regulatory treatment. I present in detail why the recent financial crisis should be considered a clear regulatory failure due to the up to date short-sightedness of financial regulation. Through providing partial solutions and professional author's assessment of selected regulatory and accounting changes to securitizations I deliver an expert's contribution to the topic. My conclusions are that securitization markets, as they have been operating until today, brought a negative net macroeconomic effect which has been largely damaging to the global economy. I argue that international and national financial supervisors established an inadequate framework for financial regulation and supervision, and among other failures, even supported credit rating agencies to further establish their businesses. Further on, I show that early warning indicators of systemic risk in the financial sector and signs of the coming turmoil were irresponsibly ignored at the time they were perceived. What turned obvious during and after the recent financial turmoil is that capital regulation failed to reach its main goal -- ensuring stability of the financial system. In particular, securitization and related credit risk transfer products were adequately treated neither in Basel I nor in Basel II. Finally, I conclude that capital ratios as established with the development of both Basel Accords are not sufficient as a central measure for banking regulation and ensuring systemic financial stability.

Abstract:

My dissertation thesis provides a comprehensive analysis of the principles of securitization techniques, of their attendant shortcomings, their regulatory treatment and the recent proposals for reducing complexity in accounting standards with relevance for securitizations. The explosion of securitization and related innovative credit risk transfer products largely expanded the magnitude and diversity of issuers, investors and securities. With this expansion numerous market participants began to wrongly believe that risk was not only shared more widely, but also that it disappeared from the system altogether. The application, or to be more precise, the misapplication of securitization in the mortgage market had fatal consequences for the financial sector worldwide. Before securitization, sub-prime mortgage lenders retained the loans that they originated on their balance sheets and therefore cared about their credit quality. Securitization techniques and related innovative financial instruments enabled the export of sub-prime mortgage structural problems from the United States globe-wide via the financial intermediaries. More over, securitization techniques and related credit risk transfer products enabled single banks to reduce their individual risk while at the same time transferred new and greater risks to the financial system. Meanwhile a lot was written on the causes for the recent financial crisis. In most cases inadequate ratings provided by the credit rating agencies and different principal agent problems were addressed. I present both for completeness in my work. However, I argue that not only the credit rating agencies are to blame for the inadequate reflection of securitization and related financial innovations and subsequently for the financial turmoil. The international and national financial supervisors in fact supported the credit rating agencies to further establish their businesses. What turned obvious during and after the financial turmoil started mid-2007 is that financial regulation failed to reach its main goal - ensuring stability of the financial system. It failed despite of the "regulatory achievements within Basel II" elaborated over the past ten years. In particular, securitization and related credit risk transfer products were not adequately treated in Basel II. Securitization-related products such as Credit Derivatives on Securitization Underlyings and numerous other complex financial innovations, as presented in my thesis, were not even thought of in Basel II. In fact, Basel II turned to do little to make the financial system more resilient. The need for further revisions in banking regulation is currently more than obvious. Furthermore, it is time to ask if the developments in Basel II are the right way to address the current risks within the financial system and hence if Basel II is the right way of banking regulation and supervision altogether. With the development of both Basel Accords (Basel I and Basel II) capital ratios became the center of banking regulation. However, capital ratios are obviously not sufficient as a measure for a systemic financial stability. These questions arise at least when financial stability and soundness are still the intended objectives and believed to be ensured through Basel II. My merits in this dissertation work root in the multi-facet analysis of securitization techniques that I provide. Up to date a comparable analysis of securitization techniques which addresses the wide spectrum of securitizations' issues - such as (i) their treatment and the related attendant flaws within the regulatory framework Basel II, (ii) the various microeconomic deficiencies related to securitizations, and (iii) the implicit macroeconomic threads of exporting credit risk and de-balancing financial stability through securitization techniques - has not been provided in the comprehensive way I built up my analysis. As a basis for my analysis, I provide a new classification of the charact

Abstract:

eristics of securitization techniques which were pre-crisis wrongly perceived as benefits. I analyze the reasons for the turmoil in the financial markets in their interplay and complexity and consider securitization techniques as a key driver for the financial crisis. I comprehensively criticize the current regulatory treatment. I present in detail why the recent financial crisis should be considered a clear regulatory failure due to the up to date short-sightedness of financial regulation. Through providing partial solutions and professional author's assessment of selected regulatory and accounting changes to securitizations I deliver an expert's contribution to the topic. My conclusions are that securitization markets, as they have been operating until today, brought a negative net macroeconomic effect which has been largely damaging to the global economy. I argue that international and national financial supervisors established an inadequate framework for financial regulation and supervision, and among other failures, even supported credit rating agencies to further establish their businesses. Further on, I show that early warning indicators of systemic risk in the financial sector and signs of the coming turmoil were irresponsibly ignored at the time they were perceived. What turned obvious during and after the recent financial turmoil is that capital regulation failed to reach its main goal -- ensuring stability of the financial system. In particular, securitization and related credit risk transfer products were adequately treated neither in Basel I nor in Basel II. Finally, I conclude that capital ratios as established with the development of both Basel Accords are not sufficient as a central measure for banking regulation and ensuring systemic financial stability.

Kľúčové slová

financial crisis, banking and financial regulation, securitization

Keywords

financial crisis, accounting for financial instruments, capital adequacy, banking and financial regulation, securitization

Jazyk práce: English

Datum vytvoření / odevzdání či podání práce: 1. 10. 2007

Obhajoba závěrečné práce

• Obhajoba proběhla 5. 2. 2010
• Vedúci: Lenka Krupová
• Oponent: Petr Marek, Jiří Doubravský

Vysoká škola ekonomická v Praze

Doctoral programme / odbor:
Finance a účetnictví / Účetnictví a finanční řízení podniku