Can trust in Securitizations be revived?

The discussion about the feasibility of reviving the securitization business revolves to a large extent about how to ensure that investors can trust the integrity of the packaging process that is behind the creation of the securities backed by the underlying loans and mortgages. The concept of securitization from the buyer's perspective means that as an investor he gets access to a multitude of loans that are individually too small to be of interest (in the case of the institutional buyer) or too large (for a small retail investor). Both are unwilling or unable to conduct individual due diligence on every single underlying loan and in effect have contracted out the credit research to the institution that creates the loan bundle they are acquiring. 
While in an ideal world the 'free market' would take care of the problem of moral hazard and ensure that no loans of questionable value are sold or purchased we do agree that the requirement for packagers to retain a substantial stake in the securitized product is a sensible suggestion. While this may well raise to cost of the securitized package we think this is a price worth paying given the abuses that helped create the credit crunch of 2007-09.

Compensation vital cost factor

Over the years we have observed the rise and (more frequently) decline of many investment banks. As compensation is the key cost factor in the industry a sensible compensation structure is essential to achieving long-term success in the business. So when we read that the centuries-old private bank of Sal. Oppenheim had agreed to pay a former chief executive of Arcandor the princely sum of 4 million Euro a year for being an advisor (and on top of it give him a three-year contract) we were not surprised that the company had to be sold to Deutsche Bank. To throw around money like a drunken sailor can only end up with the business withering away due to lack of profitability. The situation at Lehman Brothers (and the old UBS before it was swallowed by Swiss Bank Corporation) was not dissimilar. The level of compensation was completely out of whack and while it may not have been the deciding factor in the demise of these enterprises it certainly was symptomatic for a general lack of good management and governance. Sensible recruiting is one - if not the - key factor in the success of a people business like investment banking - as well as in banking, securities brokerage and investment management. 

Global Banks need Global Regulation

The collapse of Lehman Brothers which had nearly 900 subsidiaries in around 20 jurisdictions demonstrates that financial institutions that want to be active on a global basis also need to be regulated on a global basis. The alternative has to be that each subsidiary is regulated on a watertight national basis (with its own capital requirements). Politicians and Regulators have to give a clear-cut response to the question what would happen if a globally-active bank with large operations in several countries gets into serious difficulties. As banks spread their wings wider and wider - see Banco Santander and Unicredit for example - an answer to this question becomes more and more urgent. Can their clients rely on the backing of their home country or is the government of the host country expected to write a blank cheque if the worst should happen? The case of the Icelandic banks should have been a wake-up call.

Reshaping US Mortgage Market

It beggars belief that a country that prides itself of its superior financial markets is not able to provide mortgages on a private basis. Apart from the fact that state-subsidised institutions may have distorted markets and driven out private-sector institutions it is amazing that a chastised banking industry prefers to pursue profits in more exotic segments of the financial markets rather than catering to the real needs of ordinary people.

Financial Reform (No) Progress Report

Politicians, regulators and industry representatives so far do not disappoint our (low) expectations. The main idea that seems to be gathering support is (surprise, surprise!) the introduction of more taxes. As usual the proceeds of the muted taxes are not going to be earmarked and will in due course be diverted to 'socially' worthy causes. 

One regulator behind each banker!

That is the ultimate destination of the effort to create regulation for a stable banking and financial system. It is the logic of central planning (and regulation is nothing else) that the rulebooks have to be more and more detailed to cover every eventuality. In order to be effective more and more decisions will have to be supervised in minute detail by an ever-rising army of regulators. Banking professionals may love this as the bureaucrat/regulator takes all responsibility for decisions from their shoulders as each and every decision would have to be approved. A useful side-effect may be the contribution this would make to the growning lack of employment opportunities in many Western countries as it would entail a doubling of employment in the financial service sector.

USA: desperate search to increase tax revenue

It is ironic that in a week when the helpless US Treasury Secretary Tim Geithner pens a letter complaining about presumed unfair treatment of US alternative investment funds in the EU the US passes a law ('Foreign Tax Compliance Act') that forces all non-US financial institutions to report their dealings with US citizens. Against the background of a dysfunctional Congress and an administration that is spending money like a drunken sailor this desperate measure should not come as a surprise. The underlying philosophy is that a citizens' money really belongs to the state and it is up to the politicians to spend it. We do not expect the authorities to give a clear 'Njet' to this effort to extend the reach of US legislation one step further into other sovereign countries but it will do nothing to make it any easier for the US to fund its deficit in the future. Already some institutions have decided not to have any financial dealings in or with the US and as the next step may well be that the USA tries to help themselves to the wealth of non-US citizens we would advise investors to sponsor fund managers that take precautions for that eventuality.

FSA hellbent on destroying London as a financial centre

The FSA - which operates as a Quango with only the slightest amount of democratic oversight and legitimacy - intends to bring the number of paper-pushers to the incredible total of 3700 by the end of 2010. If one remembers that the City of London worked perfectly smoothly for centuries and well into the 1980s without any monstrous 'oversight' by bureaucrats the scale of this misdirection of taxpayer resources becomes more evident. When Lord 'Alliswell' clarifies that he considers much of financial market activity as 'economically' not useful he indirectly admits the intellectual bankruptcy of his thinking. To enter the debate about what is or is not 'economically useful' is a debate which only leads to the quicksands of moral do-goodism where some (usually self-appointed) authority tells other people what is good for them. The good Lord owes much of his status (and income!) to his being in favour with those in power and very little to him supplying 'valuable economic services' to the citizens. The savers in this country are those that really pay for the empire building activities of those behind the ever-expanding army of bureaucrats in the FSA. That all this spending will lead to the inevitable decline of the City of London as a financial centre is probably of no concern the the authorities. They may well talk the talk in favour of the City but one should watch what they are doing!

Deutsche Bank's Ackermann - danger of PR own goal

Deutsche Bank's Josef Ackermann fully deserves his 2009 compensation which puts him top-of-the-league for a DAX Chief Executive. It is still moderate compared with pay at some of his banking peers but it does not help his position in the global discussion about banking reform as 10 million Euro is still an amount that is way beyond salary levels that the public - and regulators, politicians and the media - feel comfortable with. To escape this dilemma it would be worthwhile to review the compensation structure of senior management - should it really be paid on the same basis as may be appropriate for a car salesman?

Bawag - problems of Private Equity or Hedge Fund Control

The diffuse ownership structure of the Austrian BAWAG Bank - where an alternative fund management firm has orchestrated a buy-out consortium a few years ago - is an apt illustration of the problems created by allowing alternative asset managers to control banking institutions. Apart from the fact that the financing often is debt-heavy there is the potential risk that conflicts of interest are not controlled properly. The age-old temptation of using a banking institution to supply credit on easy terms to controlling shareholders is one of the key areas that banking regulators have to focus on. There is also a potential conflict of interest when other banks (Goldman Sachs, Lehman Brothers in this case) are shareholders in competing institutions.