Abstract
This paper discusses the consequences of securitization and how it links to the Austrian Business Cycle Theory (ABCT). The argument that securitization is behind fiduciary credit expansion preceding the 2008 crisis is incomplete. Consolidated balance sheet analysis demonstrates that securitization per se actually sterilizes the inflationary effect of previous fiduciary credits by transforming them into credits backed by voluntary savings. This sterilization stage is subsequently followed by new fiduciary credits issuance as securitization creates excess reserves and excess capital for banks. However, when securitization is used as a tool to implement arbitrage strategies of the Basel prudential rules, it enables banks to create more fiduciary credit while time preference remains unchanged. This creates the conditions for business cycle amplification.
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Notes
Assuming a reserve requirement liquidity ratio r req then the basic multiplier is given by the following equation:
$$ Bank\ Multiplier=\frac{1}{r_{req}} $$(1)A more risk-averse banker might include, on top of required reserves, the corresponding currency drain ratio (r drain ) from deposits. Consequently, the bank multiplier equation becomes:
$$ Bank\ Multiplier=\frac{1+{r}_{drain}}{r_{req}+{r}_{drain}} $$(2)Of this, 4 % should be core capital (tier 1) while the other 4 % could be composed of supplementary capital (tier 2). Core capital consists of common stock and retained earnings, as well as any other accumulated income and disclosed reserves. Supplementary capital essentially concerns undisclosed reserves, general provisions for losses, subordinated debt, and preferred stock. The Basel capital ratio requirement is given as:
$$ {b}_{req}=0.08=\frac{capital}{risk- weighted\ assets}=\frac{tier\ 1+ tier\ 2}{risk- weighted\ assets} $$(3)In the United States, a 10 % ratio has been in practice ever since 2000 (Friedman and Kraus 2011, pp. 65, 180). See Basel Committee on Banking Supervision (2011, 2013) for detailed information on forthcoming regulation—that is, Basel III—concerning capital and leverage ratios.
Indeed, most OCDE countries propose a national guarantee of deposits (e.g., $250,000 e in the United States through the FDIC, and €100,000 in the Eurozone). The failure of a bank implies resorting to public funds to honor that guarantee.
The Basel II agreements identify three kinds of risk, namely, credit risk, market risk, and operational risk. For more on Basel II, see Basel Committee on Banking Supervision (2005).
Here follows the calculation of Bank Alpha’s weighted assets according to the risk-weights given in Table 1:
$$ \begin{array}{l} Risk\ weighted\ assets=\left[\left( Cash+ Tbonds\right)\times 0\right]+\left[ Mortgages \times 0.5\right]+\left[ Commercial\ Loans\times 1\right]\\ {}\kern6em =\left(30\ million+20\ million\right)\times 0+100\ million\times 0.5+100\ million\times 1\\ {}\kern6em \underset{\bar{\mkern6mu}}{=150\ million\ dollars}\end{array} $$SPVs, though being a separate legal entity, are intimately linked to the banks originating the loans to be securitized. Indeed, those banks hold equity on the SPVs. Moreover, credit enhancements engaging the bank to provide guarantees to the SPVs’ assets give further links between banks and their SPVs. For more on guarantees see Acharya, et al. (2013)
For more details on the terminology and the procedures relative to securitization, see Noeth and Sengupta (2011).
It is important to note that this flow description implies that reserve requirement does not apply to interbank transaction. This is the case in most monetary systems such as the European one (Banque de France 2015).
It is worth noting that this first stage is similar to the monetary reform proposed by Huerta de Soto (2006, pp. 715–812). There, bank depositors are given the choice to convert their deposits into mutual funds. This is actually a securitization operation of bank loans.
The Recourse rule and Basel II provided a regulatory framework where credit rating agencies became its keystone as risk-weighting of assets (including securitized assets) was determined by a rating that was provided by them. While Basel II regulations were gradually being implemented in other countries, the Recourse rule in its turn was fully applied in the United States by 2001.
This is an over-simplification of real world tranched-securitization schemes. Real-world structured ABS funds are more complex since they include more varied-rated tranches. However, our example still clings well to reality in terms of the proportions of the AAA-rated and lower-rated tranches. For a more realistic though complex and time-consuming description of tranched securitization, see Ashcraft and Schuermann (2008).
Here follows the calculation of weighted assets according to the weighting given in footnote 5 and the figures in Fig. 4:
$$ \begin{array}{l} Riskweighted\ assets\hfill \\ {}=\left[\left( Cash+ Tbonds\right)\times 0\right]+\left[ Mortgages \times 0.5\right]+\left[ Commercial\ Loans\times 1\right]+\left[MBS\ (AAA)\right]\hfill \\ {}\kern6em \times 20\% + \left[MBS\ (A)\right]\times 50\%+\left[MBS\ (Equity)\right]\times 1250\%=\underset{\bar{\mkern6mu}}{\$1233.8\ billion}\hfill \end{array} $$Moreover, the greater the width of the AAA-rated tranches, the greater is the economy of capital for the securitizing bank. This highlights the importance of the rating agencies in the subprime crisis. For more on this point, see White (2009).
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We would like to thank the editors and two anonymous reviewers for their insightful critiques, comments, and suggestions that helped improve previous versions of this paper.
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Giménez Roche, G.A., Lermyte, J. Securitization and regulatory arbitrage within the ABCT framework. Rev Austrian Econ 29, 67–84 (2016). https://doi.org/10.1007/s11138-015-0317-9
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DOI: https://doi.org/10.1007/s11138-015-0317-9