New FSA Chair Says Securitization Here to Stay but Must Return to Its Roots

Securitization will survive the current market crisis, in the view of new UK Financial Services Authority Chair Adair Turner, but the process must be reformed back to the original idea of securitizing assets on bank balance sheets for sale to investors in transparent simple instruments held to maturity. Also, there must be fewer layers of intermediation and trading. In remarks at the International Banking Seminar in Washington, he said that the original reason for securitization remains valid, namely taking accumulating credit assets off bank balance sheets and distributing them directly to end investors who can select desired risk return combinations and thereby reduce the concentration of risks on particular intermediary balance sheets. At the end of the day, a return to on-balance sheet lending is probably not in the cards.

In his view, securitization morphed into something much more complex, opaque and risky. Securities were packaged and structured and sliced. Derivatives were used to lay off risks, with huge unsettled counterparty exposures. And, even more defeating to the original idea, a large proportion of the securities were not in fact passed through to end hold-to-maturity investors but held and traded on the balance sheets of banks and on the off balance sheets of banks through conduits and in the highly leveraged balance sheets of investment banks.

He emphasized that regulatory regimes must now demand more capital in financial intermediation, both via higher capital requirements for banks and more effective steps to prevent highly leveraged shadow banking entities, such as the conduits, escaping capital regimes. Indeed, he predicted that the highly-leveraged shadow banks will largely disappear. There must also be more focus on liquidity prudential regimes, whether through principles and regulatory review and regulatory discretion, or via quantitative rules.