from the mouth of APRA 11 November 2013

securitisation combined with LMI was treated as a perpetual motion

machine....supported rash and sometimes fraudulent lending....was highly risky....had

systemic implications...innovation is a dirty word Malcolm!

Prudential reform in securitisation

http://www.apra.gov.au/Speeches/Pages/Prudential-reform-in-securitisation.aspx

.............From the mid-1990s to 2007, APRA and industry discovered that securitisation possesses many attractive features........

On the safety front, up to about 2007 APRA was becoming concerned, but not yet alarmed, by some of the trends we saw in the securitisation market. Concern grew from the industry’s evident addiction to unnecessarily complex structures, and the sense that some originators were treating securitisation, combined with lenders mortgage insurance, as a kind of perpetual motion machine.

Lending could be increased without the need to increase the liquidity or capital backing for this lending. There was also the concern that whatever rule APRA put in place, the industry sometimes sought corner solutions, which might technically comply with the letter, but not necessarily the spirit, of the relevant standard. ..........

During the Basel II roll-out APRA updated its securitisation approach, notably moving away from pre-vetting transactions. When the global financial crisis (GFC) hit, our supervisory resources were drawn away from securitisation for about 18 months. From around 2010, we and everyone else had a different view about the risks and benefits of securitisation, and this view had considerably darkened.  Most notably, and this is a lesson much broader than securitisation, we discovered that international money markets could shut, possibly for some time, to even the best credit propositions. Which of course makes securitisation a brittle reed upon which to base an ADI’s funding strategy, particularly any funding requiring short term rollovers.

We also discovered, thankfully in the global context rather than in Australia, that securitisation could be alloyed into a chain of transactions that supported extraordinarily rash, and sometimes fraudulent lending.  On the other hand, we discovered that despite the historic global market disruptions, by and large conventional Australian RMBS arrangements were sound, in both a liquidity and credit sense.

Moving from origination to investments, we discovered that securitisation, as one of the family of complex structured credit arrangements, could facilitate losses from investments thought to be secure, but which were in fact highly risky.

We also learned that securitisation could have more systemic implications than regulators thought was the case prior to 2008. If securitisation makes aggressive lending too easy in good times, but isn’t available to fund sound lending in adverse capital markets, then pretty clearly securitisation is pro-cyclical. This is unhelpful in a systemic sense. APRA is hopeful that its proposed reforms will reduce the pro-cyclical element in securitisation.

Then there was the surprise that all the complexity in the market, touted in various forums as innovation and completing markets, turned out to be, by and large, simply a way to conceal bad credit risks from end-investors. These investors, having learned that some complex and opaque instruments could not be trusted, panicked en masse and fled from all complex credit including unsecured lending to otherwise sound banks.

And then we discovered that banking systems reliant upon wholesale and short-term credit to fund assets, including but not limited to securitisation arrangements, could require strenuous public sector intervention to keep the banking system liquid. We also discovered that the Australian Government, should it wish to keep the Australian securitisation market at least partially open in bad times, might need to become an investor in that market.

So in summary, from say 2007 to 2011there was a fundamental global re-assessment about the value attaching to securitisation, and much of that re-assessment was distinctly negative............

read more    http://www.apra.gov.au/Speeches/Pages/Prudential-reform-in-securitisation.aspx