New Securitization Schemes: Just When You Thought It Was Safe

Includes: GS, KBE, SKF, XLF
by: John Lounsbury

Just when you thought it might be safe to go back in the water, do you see a huge shark fin lurking just offshore? The key to successful resolution of the financial system woes was supposed to be deleveraging. The U.S, and other governments collectively have put up trillions of dollars (the U.S. more than anyone else) to support the process.

I don't think there is a single person who would argue that the job of clearing overleveraging out of the financial system is anywhere near completion. And yet, new securitization schemes are being put forward by Goldman Sachs (NYSE:GS) and others.

Patrick Jenkins, writing in The Financial Times, writes:

Investment banks, including Goldman Sachs and Barclays Capital, are inventing schemes to reduce the capital cost of risky assets on banks’ balance sheets, in the latest sign that financial market innovation is far from dead.

The schemes, which Goldman insiders refer to as “insurance” and BarCap calls “smart securitisation”, use different mechanisms to achieve the same goal: cutting capital costs by up to half in some cases, at the same time as regulators are threatening to force banks to increase their capital requirements.

BarCap’s structures involve the pooling of assets from several clients into a secured financial product that can be sold on to other investors and rated by a credit rating agency, potentially reducing the capital allocated against the assets by between 10 per cent and 50 per cent.

These new mechanisms are in some respects similar to the discredited structured products, which were widely blamed for fuelling the financial crisis. But the schemes’ backers argue there are two significant differences. First, they involve the securitisation of banks’ existing assets, rather than of new lending. Second, bankers argue that the new products do not disguise the transfer of risk.

“This is the world of smart securitisation,” said Geoff Smailes, managing director of global credit solutions at BarCap. “It’s not securitisation for leverage and arbitrage purposes any more. This is all about restructuring portfolios of assets to achieve risk, capital and funding efficiency in a transparent and less complex way.”

However, some regulators may be wary of the invention of new pooled asset derivatives, especially if they are perceived as a way to avoid regulatory capital requirements.

Some rival bankers also view the schemes with scepticism. “This is a system of capital arbitrage,” said one senior banker at another investment bank. “The need for capital just miraculously disappears.”

Read the entire article here.

What kind of idiots do these fools think exist in the world? How can devising a structure which reduces capital requirements not involve increasing leverage? Engage in a liitle double talk, wave some mirrors, flash a few lights and blow some smoke you know where, and suckers will buy this stuff?

So the bankers are not disguising the transfer of risk? What are they going to do? Leave the lights on during the rape?

I may have to eat these words when I learn more details, but for now it feels good to follow my gut instinct. Hand waving and talking about achieving risk efficiency leaves a lump in my gut that will take a lot more information to resolve.

The quote about the need for capital just disappearing makes me wonder what else will disappear. I hope it is not the supposedly rescued but still badly wounded financial system rocket ship blowing up on the launch pad.

The Lex Macroeconomics & Markets column in The Financial Times has this to say about the products:

Those clever investment bankers are at it again. It was surely only a matter of time before banks tried to apply their financial innovation skills to finding ways of profiting from the very crisis that misuse of those skills brought about. Barclays Capital has found ways of pooling risky assets on banks’ balance sheets from several clients into “smart” securitisation vehicles that can be rated by a ratings agency. Unlike discredited collateralised debt obligations, however, this is about slicing and dicing existing assets, not new lending. Goldman Sachs is working on, in effect, a private sector equivalent to the asset insurance scheme run by the UK government. In both cases, this would reduce banks’ capital requirements.

On one level, such initiatives might be welcomed as industry practitioners try to find a market solution to their own problems, reducing the need for taxpayer-funded bail-outs. But there are dangers here. As studies of the origins of the financial crisis such as the UK’s Turner Review have concluded, one of the keys to creating a sounder banking system is increasing the quantity and quality of bank capital – which also, of course, means lower returns. Since the new schemes being developed are designed to cut the capital cost of risky assets, they potentially go against the spirit of such proposals.

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Disclosure: The author, family members and clients own SKF (ultra short financials). Currently no other holdings related to the one stock mentioned (GS).