These days, every other page in the financial media spells gloom and doom for the American housing market. Many banks and credit institutions are knee-deep in the mud of high delinquency and default rates within their mortgage portfolios. The mess is strongly compounded by the fact that American banks have heavily relied on the use of securitization. Thus, the risk of all those mortgages was distributed widely to many institutions (including, significantly, many important European banks). This situation was in large measure made possible by the credit ratings that the main credit rating agencies assigned to these RMBS (Residential Mortgage-Based Securities) and CDOs (Collateralized Debt Obligations). While the prices of homes in America kept going up everything was fine; but when the market turned down, default rates and delinquency soared and those fancy and complicated credit securities that were supposed to be super-safe, started defaulting. This is a very basic and rudimentary summary of the American mortgage crisis. The situation is akin to a sausage factory where you make sausage with every part of the animal but some great and solemn-sounding auditor (paid by you) states that what comes out of your factory is actually filet-mignon.
But the question I want to address is, what about Spain? Why isn't something (remotely) similar happening here? Well, there are a few important differences. Most of those American (and European) banks that I've refered to in the previous paragraph used something called SIVs (Special Investment Vehicles) to offload massive amounts of mortgage paper out of their balances. This strategy allowed them to elude stringent reserve requirements as defined under the Basel I capital adequacy agreement. As this Financial Times article reveals, Spanish banks tried to start doing that a while ago but the Spanish Central Bank demanded that they put an 8% reserve against those SIVs. This made the business completely unattractive for the banks. In addition to that, Spanish banks have been much more conservative, nah, scratch that... much more diligent than their American counterparts in their lending practices. Consequently, the default rates in the Spanish mortgage market are nowhere near the levels of the American market. Now, as Felix Salmon states here, the situation might be quite different if the housing market goes down significantly and many Spanish homeowners start feeling the pain of negative equity.
I don't want it to seem as if securitization is something alien to the Spanish banking sector: It's been used, and used significantly. But it's been done in a much more sensible way than in other parts of the world. Read this great and detailed explanation by Francisco Torralba at EconWeekly.
As everyone that knows me can attest, I don't spare criticism for Spain, its economic situation and immature financial markets. But in this case, one can only compliment the robustness of the Spanish banking sector and, above that, the very high quality of banking regulation that the Bank of Spain has developed in the last years. Somewhere in a bland Washington D.C. office, Mr. Caruana is smiling discreetly. And the Basel II agreement (in whose development he had a pivotal role) can't arrive too soon to help avoid the over-use and abuse of SIV's and the perverse incentives that they entail.
But the question I want to address is, what about Spain? Why isn't something (remotely) similar happening here? Well, there are a few important differences. Most of those American (and European) banks that I've refered to in the previous paragraph used something called SIVs (Special Investment Vehicles) to offload massive amounts of mortgage paper out of their balances. This strategy allowed them to elude stringent reserve requirements as defined under the Basel I capital adequacy agreement. As this Financial Times article reveals, Spanish banks tried to start doing that a while ago but the Spanish Central Bank demanded that they put an 8% reserve against those SIVs. This made the business completely unattractive for the banks. In addition to that, Spanish banks have been much more conservative, nah, scratch that... much more diligent than their American counterparts in their lending practices. Consequently, the default rates in the Spanish mortgage market are nowhere near the levels of the American market. Now, as Felix Salmon states here, the situation might be quite different if the housing market goes down significantly and many Spanish homeowners start feeling the pain of negative equity.
I don't want it to seem as if securitization is something alien to the Spanish banking sector: It's been used, and used significantly. But it's been done in a much more sensible way than in other parts of the world. Read this great and detailed explanation by Francisco Torralba at EconWeekly.
As everyone that knows me can attest, I don't spare criticism for Spain, its economic situation and immature financial markets. But in this case, one can only compliment the robustness of the Spanish banking sector and, above that, the very high quality of banking regulation that the Bank of Spain has developed in the last years. Somewhere in a bland Washington D.C. office, Mr. Caruana is smiling discreetly. And the Basel II agreement (in whose development he had a pivotal role) can't arrive too soon to help avoid the over-use and abuse of SIV's and the perverse incentives that they entail.
