The safety valve for US lenders that Europe has yet to reproduce
By Gillian Tett
Published: December 21 2007 02:00 | Last updated: December 21 2007 02:00
Why exactly did Northern Rock collapse? That question has prompted endless handwringing in the UK, as the political implications of this troubled saga continue to grow.
Over in the US, some policymakers are also furtively mulling over this issue - but in reverse. For what people in the US are trying to understand is why the Northern Rock saga has not been repeated all over the Land of the Free in recent months.
After all, the US has plenty of lenders who (like Northern Rock) carve a business by using mortgage collateral to raise finance in the markets.
Yet, when the mortgage securitisation markets froze this summer, the US did not see a string of embarassing failures - even though mortgage lenders such as Countrywide were flashing red on regulators' screens.
Why? Some US bankers like to attribute this difference to superior treasury skills. Some might also point out that the country has a better system of retail depositor insurance than the UK. And, of course, the US Federal Reserve took a more active and soothing stance than the Bank of England during the early autumn.
However, I suspect the real reason for the contrast lies in an issue which is almost never publicly discussed: the presence of the Federal Home Loan Bank system.
This is a part of the US financial system which few outside the US know much about. What the FHLB essentially does is raise money cheaply, by virtue of having an implicit state guarantee. It then uses this to provide loans to other financial institutions, against their mortgage collateral.
The important point to grasp is that these loans have quietly ballooned in recent months: as my colleague Krishna Guha recently noted, the Fed's Flow of Fund data shows that the FHLB system issued new loans to mortgage lenders at an unprecedented annualised rate of $746bn in the third quarter of this year. That was up from practically nothing in the second quarter. And while the FHLB does not name the lucky recipients of this largesse, the cash almost certainly went to institutions no longer able to fund themselves in the normal way - ie through the capital markets. ( or just did not WANT that transparency, so Hank Paulson gave them their "privacy", how tres cool is THAT .. for the banks anyway.)
In some respects, this is cheering stuff. For what the Fed data show is that the US now has an inbuilt safety valve for its mortgage world - and, moreover, one that is pumping funds into the system at a much greater rate than the Fed itself.
But there is a nasty sting in the tail. Since the FHLB enjoys an implicit government guarantee, taxpayers will be on the hook for any future losses. And while such losses have not yet occurred, regulatory oversight of this sector is thin. The FHLB safety valve, in other words, may yet produce some nasty surprises further down the road.
So what, in the meantime, should European politicians conclude? Right now, there seems to be little chance that Europe might copy the FHLB. After all, British taxpayers, say, are probably in no mood to accept more subsidies to the banking world.
But perhaps the real moral is that investors in Europe's securitisation market have, in a sense, been sold a pup. In the past decade, the US has often been hailed as the cradle of modern financial capitalism, partly because it has been so wildly innovative in areas such as mortgage
securitisation.
But now it is clear that this market innovation was partly built on the presence of an obscure state safety net. Europe's problem is that in the past decade it has copied US financial innovation - such as mortgage securitisation - without adopting the other safety valves that the US had
too.
Worse still, nobody noticed this gap until it was too late. Hence the fact that when the global mortgage securitisation market suddenly froze up this summer, Northern Rock belatedly discovered that it could not readily tap state alternatives, unlike its counterparts in the Land of the Free.
It is a salutory tale - not just for Britain's bruised bankers, but for anyone else who ever believed too readily in the dream of a united, free capital markets world.
Over in the US, some policymakers are also furtively mulling over this issue - but in reverse. For what people in the US are trying to understand is why the Northern Rock saga has not been repeated all over the Land of the Free in recent months.
After all, the US has plenty of lenders who (like Northern Rock) carve a business by using mortgage collateral to raise finance in the markets.
Yet, when the mortgage securitisation markets froze this summer, the US did not see a string of embarassing failures - even though mortgage lenders such as Countrywide were flashing red on regulators' screens.
Why? Some US bankers like to attribute this difference to superior treasury skills. Some might also point out that the country has a better system of retail depositor insurance than the UK. And, of course, the US Federal Reserve took a more active and soothing stance than the Bank of England during the early autumn.
However, I suspect the real reason for the contrast lies in an issue which is almost never publicly discussed: the presence of the Federal Home Loan Bank system.
This is a part of the US financial system which few outside the US know much about. What the FHLB essentially does is raise money cheaply, by virtue of having an implicit state guarantee. It then uses this to provide loans to other financial institutions, against their mortgage collateral.
The important point to grasp is that these loans have quietly ballooned in recent months: as my colleague Krishna Guha recently noted, the Fed's Flow of Fund data shows that the FHLB system issued new loans to mortgage lenders at an unprecedented annualised rate of $746bn in the third quarter of this year. That was up from practically nothing in the second quarter. And while the FHLB does not name the lucky recipients of this largesse, the cash almost certainly went to institutions no longer able to fund themselves in the normal way - ie through the capital markets. ( or just did not WANT that transparency, so Hank Paulson gave them their "privacy", how tres cool is THAT .. for the banks anyway.)
In some respects, this is cheering stuff. For what the Fed data show is that the US now has an inbuilt safety valve for its mortgage world - and, moreover, one that is pumping funds into the system at a much greater rate than the Fed itself.
But there is a nasty sting in the tail. Since the FHLB enjoys an implicit government guarantee, taxpayers will be on the hook for any future losses. And while such losses have not yet occurred, regulatory oversight of this sector is thin. The FHLB safety valve, in other words, may yet produce some nasty surprises further down the road.
So what, in the meantime, should European politicians conclude? Right now, there seems to be little chance that Europe might copy the FHLB. After all, British taxpayers, say, are probably in no mood to accept more subsidies to the banking world.
But perhaps the real moral is that investors in Europe's securitisation market have, in a sense, been sold a pup. In the past decade, the US has often been hailed as the cradle of modern financial capitalism, partly because it has been so wildly innovative in areas such as mortgage
securitisation.
But now it is clear that this market innovation was partly built on the presence of an obscure state safety net. Europe's problem is that in the past decade it has copied US financial innovation - such as mortgage securitisation - without adopting the other safety valves that the US had
too.
Worse still, nobody noticed this gap until it was too late. Hence the fact that when the global mortgage securitisation market suddenly froze up this summer, Northern Rock belatedly discovered that it could not readily tap state alternatives, unlike its counterparts in the Land of the Free.
It is a salutory tale - not just for Britain's bruised bankers, but for anyone else who ever believed too readily in the dream of a united, free capital markets world.
No comments:
Post a Comment