The Wall Street Journal recently reported that the Papacy has denounced securitization characterizing it (in such an intellectually balanced way) as tainted by “predatory and speculative tendencies.”
Now, I’m not perfect — I can’t remember the last time I participated in a black mass, inverted a crucifix or committed any of the more striking of your basic mortal sins — but I did close a securitization last week and now I’m worried.
What the hell is going on? All this can be found in a teaching document issued by something called The Vatican Offices for Catholic Doctrine and Social Justice and included in this bucket of the iniquitous was securitization and credit default swaps, which they characterize as “gambling on the failure of others which is unacceptable from an ethical point of view… a kind of an economic cannibalism.” Cannibalism?
I have no major problems with the Catholic Church (I love their artwork) nor the current Pope, although I have found, as a member of the Adam Smith Fan Club, somewhat off–putting Pope Francis’ recent reconciliation with the liberation theology of Latin America. He is clearly no fan of capitalism (“Fundamental terrorism against all of humanity” – Really!). But isn’t His Holiness straying a bit far from the priestly piest in this bit of polemic pedagogy? On top of that, he is wrong.
Present company aside, I know some really decent folks involved in the securitization industry and to denounce the technology as amoral, and imply the hand that wields it is too, ex cathedra, seems a bit much.
And, oh, if only His Holiness were alone in this error. Ever since 2007 the literature has been full of articles such as Not All Securitization Banks Are Evil, or Can Securitization Make A Comeback?. All broadly denouncing securitization as the Patient Zero of the Great Recession. The Big Short was fun and made a great movie but it really paints an ethically dim picture of the folks who used securitization to provide capital to the residential mortgage market and made dysfunctional heroes out of the gang who figured out these deals fundamentally didn’t work.
And look at what the Europeans have said about securitization. Several years ago, they broadly denounced it as some form of fundamental evil and the regulators made it virtually impossible for prudentially regulated banks to use the technology through nose-bleed inducing risk-based capital charges and public shaming. Recently, the Europeans have begun to wonder whether they had that right and we have recently seen a half-hearted effort to return the technology to the land of moral rectitude through the STS — simple, transparent and standardized — securitization. These rules don’t make much sense and create distinctions based on underlying asset classes as to what is an STS and what is not in a way that is really not helpful. But hey, give them a break; the Europeans are trying to walk back bad decisions fueled by an ideological distaste for Anglo-Saxon Bullshit. This represents a recognition, late and grudging, that the need for capital across developed economies cannot be met by the lending capacity of the European prudentially regulated banks. And don’t get me started about the obvious ills of the EU banking system and the dodgy nexus between politics and national champion banks! (More on Italy next week.)
Relying upon the banking system alone to fuel your economy is an unhedged bet that no one should be making today.
The broad indictment of securitization comes from a well of ignorance and an ideological distrust of markets.
Here’s a flash for the Vaticans, Brussels and all those other constituencies who find securitization, an easy target for vilification. Capital formation is about borrowing short and lending long. Most of the time it works and sometimes it doesn’t. When it doesn’t, it’s bad, but the cycle of working and not working has progressed with astonishing regularity for say, about, the last 10,000 years. Think of Jimmy Stewart’s little bank; it took deposits and lent the money out to local establishments to buy buildings, inventory, pay payroll and otherwise run their businesses. (Flash for the financially illiterate: Deposits are liabilities of the banks. Deposits can be withdrawn overnight (see movie)). This is the classic example of borrowing short and lending long. That’s the basis of the banking system and whether it’s Potterville or a world-girding money-center bank, that’s the fundamental nature of that business.
What’s securitization? Borrowing long and lending long. What? No mismatch of liabilities and assets? And that’s bad, how? Critics say it is leverage on leverage. Well, that’s right, but, it’s really no different than a bank book supported with deposits. Seems to me that the durational matching of assets and liabilities, on balance, is kinda good.
Securitization is just a technology that allows a broad investor universe to fund the users of capital without intermediation through the banks. That broad universe of investors is much deeper than the balance sheets of all of our prudentially regulated banks, and once again, let’s remember that our banks find their money through deposits or from short term borrowing. Structurally, therefore, one can argue that securitization is a more stable financing structure than the basic banking model.
In the Great Recession, many structured finance transactions failed. Note to file: Many banks failed, as did government-sponsored enterprises and other non-bank lenders. One could argue that the failure of structured finance vehicles was to some extent priced-in and anticipated. Investors made bets based on their judgment as to the credit risk inherent in the transactions that they financed. This is not Ma and Pa Kettle dumping money into a savings and loan in Oshkosh; these are large financial enterprises making considered bets on pools of assets with considerable understanding of the assets, liabilities, and the structure.
Were there mistakes and even abuses that caused losses? Assuredly. Can any tool be misused? Without a doubt. Were all the risks of the things which securitization vehicles invested in understood? Demonstrably not. Is some of the fault here on account of the bankers who embraced these securitization structures with exuberance? Certainly. But while our federal government and any number of states’ attorneys general have been beavering away to make the banking sector the bad guy and appear entirely comfortable with the notion that the fault lay exclusively with the perfidious banks, that simply wasn’t true. Often the risk of these transactions were breathtakingly clear and ignored by investors, rating agencies, governmental entities and the professionals who worked in the space, all who share some blame for structures that didn’t work and assets that didn’t perform. But that’s neither an indictment of the technology or of the industry that has successfully deployed a large amount of capital to help our economy grow.
So does this screed have a point? It does. It’s not too late to fight the securitization is evil narrative. In a world where we are not just entitled to our own opinions, but apparently to our own facts, narratives become ossified into facts and decisions are made with little patience for contrary positions. The industry, its trade organizations and participants, need to make the case that securitization is not an evil tool of perfidious bankers, but a critically important component of our economy. If we don’t, we’ll have no one to blame but ourselves when economic stress returns to our marketplace, bad things happen to good people and the pitchfork and burning torch gang go looking for a monster.