The year is 2009. Barack Obama has recently been elected (for the first time) and we are in the midst of the “great financial crisis”. He uses his first address to Congress to discuss the state of the economy, the central message being that without finance the very lifeblood of our economy is removed. 

These types of metaphors are not new. Ever since William Harvey first enlightened us to the workings of the circulatory system comparisons between blood and finance have been numerous. 

A little history of securitisation 

Indulge us for moment as we take a walk down memory lane. Securitisation, as we know it today, really started in the 1970's, but its history can (arguably) be traced back to 1769 and the first pfandbrief (at that time, bonds issued by collectives of Prussian nobility backed by pledges of their estates). In the 1800's USA, bonds were issued secured by farm mortgages that the banks had previously brokered. 

Securitisation grew in size for a number of reasons. It can give liquidity to otherwise illiquid assets, provide access to cheaper funding, reduce regulatory capital and it allows a diversification in investors’ holdings, to name but a few. 

Back to blood. We saw during the “great financial crisis” (GFC) how certain tainted assets, some might even say poison, found their way into the financial blood stream. The sheer amount of such tainted assets was not, in and of itself, sufficient in size to cause significant, never mind catastrophic, damage to the organs of finance. 

The medicine

As with many illnesses, ‘doctors’ (in the form of regulators) were called upon to cure the patient of the disease. Some doctors were swift in their diagnosis: the poison was most likely securitisation. 

But what if the diagnosis was wrong? The ‘poison’ that entered the system was not securitisation. Securitisation isn’t an asset, or a product in itself. It is a technique which can be applied to many different asset classes across a broad range of investor markets. Securitisation forms part of the circulatory system and is but one way of transporting financial oxygen to economic muscles.

The true “poison” was in the form of the mortgage loans made on unaffordable terms to US consumers who were then unable to repay them. To the extent that those mortgages formed part of the collateral for securitisation bonds, those particular securitisation bonds defaulted. This was and is how securitisation is supposed to work – the investor is buying the performance of the assets that back the securitisation bonds, with its exposure (and return) varying according to which part of the credit risk it decides it wants to take. The crisis arose, however, because investors lost confidence in institutions perceived to be excessively exposed to such mortgages (and in some cases the loss of confidence became a self-fulfilling prophecy as liquidity for those institutions disappeared). 

Regulators have frequently also attributed the GFC to a lack of transparency. However, the lack of transparency was not at the individual securitisation level, but rather at a system level where it was either not understood or clear as to who was holding what. The regulators have gone a long way in making improvements in system-wide transparency since then.   

But an overarching regulatory reaction in many respects, particularly in Europe, was akin to a pronouncement by an 18^th century physician that the patient was “extra-sanguinary” and a prescription requiring a reduction in the amount of blood in the system. In Europe the medicine has been remarkably effective in that regard – the recently released consultation on the functioning of the EU Securitisation framework notes the decline in European securitisation from EUR 2trn at its peak to EUR 1.2trn at the end of 2023.   

The effect on the patient 

In all of this have we though lost sight of the patient (if we take the patient to be the wider financial system)?

One thing that is clear to practitioners in this field is that the “cure” for what ails securitisation is not regulation of the type that has been visited upon it. The physicians have loudly and repeatedly announced that such regulation will restore confidence in securitisation and allow it to flourish. A 40% reduction in market size between the mid-noughties and 2023 strongly suggests otherwise. Indeed, it may well revive itself more easily and organically were the “treatment” to cease. This is not to say that securitisation (or indeed any financial product) should not be regulated appropriately. But in finance, like medicine, we need to make sure we are prescribing the most up-to-date treatment, to be willing (if needed) to completely re-think the treatment plan, to test it against current knowledge and most importantly to ensure that the patient is receiving the best possible treatment. 

Other markets have bounced back more strongly which begs the question of whether some other medicine may be better. To treat a patient we need to be willing to really understand it and not to assume that we already have all the answers. 

The new medicine 

The recently announced consultation on the EU securitisation framework is perhaps finally the opportunity to properly assess the medicine and make an honest and objective assessment as to whether it is working.  

Securitisation has, for too long now, been simply surviving. At times it has felt like that survival has been against the odds. 

Now it is time to let it thrive.