Complex debt deals caused mayhem, but we need them

The European Central Bank was surrounded by protesters demonstrating against economic and financial policy as part of the Occupy movement in 2011 (Getty)

The “exploited and abused” practice of banks parcelling up debts to sell on to investors in the build-up to the financial crisis needs to be revived, in a more transparent form, deputy Bank of England governor Sir Jon Cunliffe said today.

The securitisation market has been all but closed since 2007 when the global financial system was first paralysed by fears over the value of “toxic” bonds based on high-risk loans and “sub-prime” entered the financial lexicon. Ratings agencies have come under huge fire since the crisis for inflating the creditworthiness of a host of securitised assets - left virtually worthless by the crash - to win business from the banks issuing the bonds.

Sir Jon said complex financial instruments should be made more transparent to revive a market badly hit by the crisis, as well as ensuring the banks retain some exposure to the loans underpinning them. He said the aim was “to develop standards so that it does what it says on the tin; but it is actually a jar. You want a label on the outside of the jar that is clear, that uses understandable terms and... you can see into the jar,” he said in a radio interview.

Sir Jon Cunliffe, left, pictured with the current Governor of the Bank of England, Mark Carney (Rex)

Sir Jon’s comments come after the Bank and the European Central Bank set out proposals to resurrect the market for asset-backed securities and help the flow of credit to smaller businesses. ECB president Mario Draghi is expected to set out plans to buy up parcels of small business loans issued by banks to improve corporate credit on Thursday.

The deputy Governor said securitisation “was exploited and abused and it spread risk throughout the system”. But he added: “We want to see if the market can develop standards and ways of doing this that actually deals with the risks that we saw crystallise - and that can enable securitisation to happen in a beneficial way. Clearly what the market has to do if we want to develop this mechanism is do so in a way that is simple, robust, transparent and investors can know and predict the risks and the payoffs of the instruments they’re buying.”

He said in an interview with BBC radio: “There is risk in lending, it is about understanding the risk, pricing and providing collateral. This is not about making lending riskless. We want to make it safe in the sense that people can understand what it is they’re doing.

Meanwhile the fall-out from the previous boom in securitisation and its subsequent collapse lingers on. Ratings agency Standard & Poor’s is fending off a $5 billion lawsuit from the US Department of Justice for fraudulently misrepresenting the ratings of mortgage-backed bonds. The agency contends that the action - first launched last year - comes in response to its controversial decision to strip the US of its triple-A credit rating in the summer of 2011. Calpers, California’s state pension fund, is also suing S&P and rival Moody’s over ratings on investments which led to $800 million in losses after the agencies failed in a bid to dismiss the suit.