Lessons from the Subprime Crisis

In recent years securitisation, i.e. financing loans directly via capital markets, has considerably gained in importance and frequency. The subprime crisis has exposed its deficiencies, however. When mortgage financiers were able to shift the credit risks to the capital market the lending standards declined significantly.

As a consequence the subprime credit market tripled within just a few years. When interest rates finally went up many borrowers stopped repaying their debt and the ultimate financiers of the loans – banks and so-called structured vehicles – suffered sizable losses. Meanwhile the sum of depreciations in the financial sector amount to more than 500 billion US dollar, the burden being almost equally shared between Europe and the US. These obvious deficiencies do not, however, discredit the securitisation technique as such because the benefits generated by the improved allocation of risks are substantial. Yet, the market needs restructuring. For example, the originators should carry a significant share of the default risk and the securitisation products should be simplified. In addition, rating agencies should appraise risks more cautiously and investors should pay more attention to a product‘s transparency.