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August 27, 2008

Crisis Alters Banking Structures

Charles Calomiris
Henry Kaufman Professor of Financial Institutions
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Professor Charles Calomiris presented his thoughts on the long-term ramifications of the subprime housing crisis as part of last week’s annual gathering of economists in Jackson Hole, Wyo. The following excerpt was originally posted on Vox. (download complete paper)

The financial system is working through a major shock. It started with problems in the subprime mortgage market but has spread to securitization products and credit markets more generally. Banks are being asked to absorb more risk — moving off-balance sheet assets back onto their balance sheets — when their ability to do so is reduced by massive losses. The result is a bank credit crunch as the scarcity of bank equity capital is forcing banks to limit exposure to new risk.

What long-term structural changes in financial intermediation will result from the subprime turmoil? One likely outcome is the conversion of some or all standalone investment banks to become commercial (depository) banks under Gramm-Leach-Bliley. The perceived advantages of remaining as a standalone investment bank — the avoidance of safety-net-regulation and access to a ready substitute for deposit funding in the form of repos — have diminished as the result of the turmoil.

The long-term consequences for securitization will likely be mixed. In some product areas with long histories of favorable experiences — like credit cards — securitization is likely to persist and may even thrive from the demise of subprime securitization, which is a competing consumer-finance mechanism. In less time-tested areas, particularly those related to real estate, simpler structures, including on-balance sheet funding through covered bonds, will substitute for discredited securitization in the near term and perhaps for many years to come.

Photo credit: Michael Daddino


by Dmitriy Dorosh | August 27, 2008 at 1:17 PM

Looks like a very good report. One thing i need to mention is that it all sounds perfectly fine in theory. I have to point out that in practice it's always different. Once you are trying to follow the theory and then there are things like competition, profitability and many other major factors that have to be accounted in for a decision. Once you put all this together, it become a lot different from what should have been done in theory.

by zac W | September 03, 2008 at 12:26 PM

This is a very to the point written point. Thanks.

by Mike Fischer | September 04, 2008 at 8:35 PM

Well written article. Great read. http://www.resp-canada.ca

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