The Pot calling the Kettle black...

This week the Federal Deposit Insurance Corp (FDIC) - the body responsible for insuring US bank deposits - took over its 100th failed bank. That's a lot of banks. The plethora of failures since the start of the financial crisis means the organisation now has control of billions of failed bank assets. As an organisation, FDIC is not alone - plenty of state and semi state bodies around the world are dealing with similarly huge volumes of bad "legacy" assets.

Back when Northern Rock was one of the world's first bank failures, one of the big faults ascribed to their banking model was the excessive use of wholesale funding, and in particular, securitisation. Securitisation allowed Northern Rock to originate loans massively disproportionate to the size of their capital base, because these loans were repackaged and sold to other institutions around the world as bonds from these securitisations. Northern Rock would only hold the risk of the loans they were making for a short period of time, before refinancing in this way. Their problems arose when the securitisation market shut abruptly and the bank was stuck with huge quantities of loans that it couldn't finance. The scenes of customers queuing to take their deposits back followed shortly thereafter.

For a time, securitisation had allowed Northern Rock to be very successful - it allowed them to improve their regulatory capital position, improve their ratings, increase the size of their loan portfolio, and reduce their overall cost of funding. Basically without altering the fundamental nature of their business, they were able to massively increase their return on equity. In the aftermath of the fallout of all of these bank failures there has been plenty of commentary on the fact that securitisation was part of the toolkit that allowed the financial institutions to pile leverage into the world's financial system. Consequently it is recognised as a significant contributor to the financial crisis as a whole. We can all recall how governments around the world attacked "the rating agencies" for their complicit role in helping banks to create ABSs, CDOs, SIVs and all the acronyms that went with this form of financial alchemy.

Now we are at the point where bank failings around the world have left governments and their taxpayers carrying the can. Budget deficits, as I've written about before, are sky high in countries like the UK, the US, Ireland and Spain. Essentially the private sector problems of the banking system have become public sector problems, and governments are exploring all sorts of options to finance these bad debts in the most efficient ways. They have the same problem that the banks did - how to maintain ratings, meet budget targets, tidy-up balance sheets etc. State institutions like FDIC have a huge quantum of assets to find financing for.

With no great awareness of the irony, it was intriguing to read this week that one of the options that FDIC are considering is the "mother of all securitisations". Michael Krimminger, special advisor for policy at FDIC, speaking at the ABS East conference in Miami said that "it is likely that they may seek to do a securitization". Brilliant. And they are not alone. In Ireland, the National Asset Management Agency (NAMA), which is taking on a €77 billion notional of bad loans from Irish banks, is apparently creating a "special purpose vehicle to acquire the loans. NAMA will own 49% of the SPV, with the remaining 51% belonging to as yet unidentified private investors". In other words, they want to do a securitisation to shift most of the debt off the country's balance sheet.

Ireland's budget deficit is a focus for Eurostat, who monitor European Union members' economic position particularly when one of its members is likely to breach one of the pillars of the Stability and Growth Pact. This agency, which in theory is aimed at protecting European Union "growth" and "stability" is actually advising the Irish government on how it can keep NAMA "off balance sheet", so that it meets European Union fiscal rules. Surely there is something wrong with this?

While I still believe that there is some merit in the process of securitisation, one of the big issues I have with it relates to transparency. When a securitisation involves shifting risks off-balance sheet, but where there is some residual risk that these liabilities may come back onto balance sheet, then not accounting for that contingency in any way would appear odd. It is a form of organised delusion, and goes against the worldwide state calls for greater transparency in the financial system.

The Irish Finance Minister, Brian Lenihan confirmed: "The preliminary decision of Eurostat means that the acquisition of the assets from the financial institutions by NAMA may be treated as off-balance sheet in the budgetary arithmetic under European national accounting rules. In other words, it will not increase the general government debt ratio, and neither will our budget balance be directly affected by the NAMA initiative."

This great from an accounting perspective, but NAMA will sell the 51% to private sector investors, with a state guarantee - i.e. in the event that the underlying loans don't perform well enough to pay bondholders what they are owed, the Irish government will pick up the tab for the difference. NAMA is therefore an ongoing contingent liability for the Irish government, even if their accounts don't show it. This is exactly where the private sector problems with the banks that are being bailed out started. Off balance sheet liabilities that weren't accounted for made the numbers look good when the times were good, but when the assets started performing poorly, the liabilities moved from being "contingent" to actual and immediate, and the system started to break down.

In my old jobs at Lehman Brothers and BNP Paribas, we helped banks perform securitisations for various reasons from funding, to improving their "regulatory capital position", and we made a lot of money from doing it. Some of it was sensible, but the vast majority of the business was a form of organised delusion - trying to make something look better than it actually was. I can only imagine that the semi-redundant masters of this art form currently still in these investment banks are rubbing their hands together at the prospect of "helping" the governments of the world in the same way.