'Securitisation, Ring-Fencing and Housing Bubbles: Financial Stability Implications of UK & EU Bank Reforms (forthcoming, Journal of Financial Regulation, 2018)'

Abstract: Declines in property markets played a central role in the Great Financial Crisis. Off-balance sheet financing activities, particularly securitisations, were used to fund higher volumes of bank lending, concentrated in real estate. Post-crisis reforms and low investor appetite for securitisations have so far impeded any reincarnation of such markets. In response, the European Union has proposed a new Securitisation Regulation, with the aim of restarting EU securitisation markets. This article explores the possible legal and economic significance of this Regulation and argues that current analyses of the likely effects of securitisation on asset markets, particularly housing markets, are deficient. Instead of highlighting flaws in the securitisation process through improved incentives – which I term ‘process-focused’ regulation – analysis of incentives ought to concentrate on the excessive credit-origination which techniques such as securitisation facilitates. This is particularly relevant to housing bubbles, the greatest threat to financial stability. Housing bubbles in general are driven by over-optimistic expectations about future house prices, which are shared by both borrowers and investors. Improving incentives in credit-channel widening structured finance when all parties are over-optimistic is unlikely to guard against future bubble formation. This is particularly relevant to the UK market in light of structural reforms to the UK banking sector (so-called “ring-fencing”), which is likely to result in today’s large UK universal banks being converted into monoline mortgage lenders.