Why is Europe Surprised? A World without Securitization

Over the last few weeks there have been a series of articles detailing the growing concerns about the seemingly accelerating rate at which European banks are adopting the new Basel III capital and liquidity rules.  Phrases like “aggravating the region’s economic woes” and ” the unintended consequences” are being thrown around liberally.  As a result of this migration towards the “new normal” in global bank capital standards, many are fearing that any chance at even a modest recovery in the Euro zone will soon be choked-off.

What we don’t understand is why anyone is surprised by any of this.  Surprised?  Really??

Without a robust securitization market to absorb the excess demand for fairly priced capital, not just in Europe but for the global economy, the markets continue to struggle.  It’s just that more evident in Europe than it is in the US for several reasons.  Two interdependent phenomenon that come to mind are:

1-  The European securitization markets were never as well-developed as their US counterparts, even before the Credit Crisis.  The “junior” status of this market was due to several factors, perhaps the most significant of which was the varied commercial and property laws and regulations throughout Euroland which made the whole process of securitization that much more complex.

2- Partially as a result and throughout the boom years, the European market had a disproportionate over-reliance on traditional bank lending for capital and now it appears that the bird has come back to roost.

So, what we now have is perhaps the clearest example of the consequences associated with forcing banks to de-leverage while simultaneously shutting off the securitization market.  No matter how you slice it, something has to give and that “give” quite naturally points to a contraction of the European economy.

Unfortunately, many market regulators (see the US Federal Reserve in a recent commentary) are still pointing to the scary specter of the “Shadow Banking System” like it is some close relation to Freddie Krueger.  This, of course, is where securitization operates; outside the banking system and “off” the balance sheets of the banks.  We could not disagree more with those who suggest that allowing non-bank investors into the capital markets via securitization is a bad thing.

The answer to this mess remains the restoration of structured finance as the most pragmatic and successful way to allow non-banks to participate in the funding of the “global balance sheet”.  Too many companies chasing too little credit in a “bank only market” is a recipe for disaster.  We hope that the ECB takes the first step in the right direction very soon by allowing banks to utilize high quality ABS and MBS securities against their short-term liquidity ratios.

We believe that just as the current conditions are pointing towards the need to restore securitization, allowing banks to utilize ABS and MBS securities to meet liquidity requirements will reinforce the fact that securitization actually does work and is distinctly and morally beneficial to the global financial system.

BoA CEO Compelled to Testify in MBIA Case

New York Supreme Court Justice Eileen Bransten’s decision to reject Bank of America’s request to relieve their CEO from having to testify in the long running case between MBIA and BoA over MBIA’s insuring of many of Countrywide Mortgage’s late vintage RMBS financings may have the effect of accelerating the resolution of a case which continues to hang like a cloud over the recovery of both companies and the mortgage-backed markets.

The judge ruled that BoA CEO, Brian Moynihan, may in fact have some very relevant information to lend to the case and therefore MBIA should be able to bring him to the witness stand.  The judge cited both Moynihan’s role as head of the integration of the Countrywide acquisition and his responsibilities as head of BoA’s Investment Bank during at least some of the time that the events are alleged to have taken place, as very good reasons for rejecting BoA’s request.

We won’t take sides but, whatever the outcome, we believe that the market will benefit from a speedy resolution.  Assuming that both MBIA and BoA are not too seriously harmed by the result, we believe it would also assist the recovery of both of these former high-flyers that have been so clearly limping along over the last several years, at least in some part, because of this case.

Perhaps the prospect of calling the CEO to the stand will accelerate the resolution process.

Rating Agency Wars Continue to Heat Up

Recently, we noted that Moody’s had been critical of other rating agencies for their overly generous ratings on recent asset-backed financings (see post of March 20th).  We wondered if Moody’s motivation was based only in its desires to provide the market with a consistently more objective point of view and to not have all the nationally recognized rating agencies return to the complacent days of the last decade and before the market crisis.  We hoped that the motivation was not one based on Moody’s not being asked to rate some or all of these programs.

Well, perhaps not surprisingly, last week Fitch jumped into the pool by blasting Standard and Poor’s and the Canadian based agency DBRS for their work on a recent mortgage-backed bond issued by Credit Suisse.  In a much more “connect the dots fashion” Fitch let it be known that they had not been asked to rate the issue and, if they had, they would have found serious faults in the underwriting or due diligence process that led to unreliable projections for valuations of the underlying properties.

In a perfect world, Fitch’s conclusions would seem to indicate a real and significant difference in  rating methodologies between Fitch, S&P and DBRS in an important area of the rating process.  Such news would be good for investors as it might indicate that in some cases, issuers might be looking to shop for softer treatment from some rating agencies and, depending on an investor’s risk tolerance, relying on a more conservative rating agency’s analysis might fit certain types of investors better than others.

Other, perhaps more jaded observers, might as we discussed in our last article on this topic, be inclined to believe that the dissent might be more tied to being left out of the process than any substantial disagreement with the work of S&P and DBRS in this transaction.  We are not ready to align ourselves with that decidedly more cynical view of the situation but certainly it remains one area where holders need to stay on their toes.  We, for one, would like to see a greater diversity in views making its way into the rating analysis, as it would make for a better overall outcome if folks became accustom to challenging conventional wisdom on a routine and not only on an exception basis.