Discussion of A Model of Shadow Banking
(by N. Gennaioli, A. Shleifer and R. Vishny)
Oscar Arce
CNMV - Research and Statistics Department
Director
Debt and Credit, Growth and Crisis
BdE - WB
Madrid, 18 June 2012
What the paper does
1. It provides a comprehensive story on the links between aggregate savings
(the savings “glut”), the scarcity of safe assets and the role of securitization
in their production, interest rates, leverage and financial stability.
2. A relatively simple model:
- A demand for safe assets by risk-averse investors (lenders)
- A supply of safe assets by risk-neutral intermediaries. Two cases:
i) If low demand, intermediaries’ own collateral suffice to meet it
ii) If high demand, intermediaries produce new “safe assets”
securitization
3. Central results:
i.
If risks are correctly assessed, securitisation contributes to financial
stability (risk diversification -pooling) and is Pareto-improving (efficient
risk allocation –tranching and originators retention).
ii.
If tail risks are neglected, securitisation may become a driver of financial
instability through ex post 1) excessive leverage and 2) illiquidity
What I like most
- A relatively simple model sheds light on the links between some key
developments before and during the crisis in a credible way
- The shocks-transmission mechanisms (aggregate contagion of idiosyncratic
risks through securitization and illiquidity) help understand the velocity and
intensity with which the initial turbulences of August 2007 spread over the entire
system
- Some key pieces in the model are well grounded on empirical evidence:
 The role of securitization in producing high-quality assets
 The role of securitization holdings by leveraged intermediaries in amplifying the
shocks
Key model elements (I)
 The role of securitization in producing high-quality assets:
Global issuance of AAA-rated long-term fixed income assets (1990-2009)
7.000.000
Million dollar
Sovereign debt
Corporate bonds
As a percentage of total (right-hand scale)
ABS (agencies included)
Other long-term debt
%
70
Source: Dealogic
6.000.000
60
5.000.000
50
4.000.000
40
3.000.000
30
2.000.000
20
1.000.000
10
0
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
The rapid growth in global AAA-assets (from 20% of total assets in 1990 to 60% in
2003) was largely due to securitisation
Key model elements (II)
 The high volume of securitization in the leveraged institutions’ balancesheets (key for the transmission of shocks in the model and in reality too):
Distribution of the holdings of GSE-backed securities
Source: Shin (2009)
Leveraged institutions (commercial banks, investment banks and hedge funds) were the
main holders of ABS
What I find less convincing
 A “static” and “partial equilibrium” framework is used to explain some
facts of “general equilibrium” (systemic) nature, thus missing some
interesting dimensions, e.g.:
- In the model only one type of productive investment which exogenous wrt to how
it is financed.
- In reality, most problematic ABS were linked to mortgages (RMBS and CMBS).
Some argue that the housing bubble was indeed fuelled by securitisation
- A conjecture: if securitisation favours the emergence of housing bubbles, then
securitisation may not be that good in the first place, even under RE (e.g. in terms
of financial stability or general welfare –e.g. Arce & López-Salido 2011)
- A (big) conjecture: can “too much” securitisation generate endogenous aggregate
instability through its effects on the investment mix?
What I find less convincing
 The assumption that originators (think that) retain all the risk seems at
odds with data ----too little “skin in the game”
Tranche retention by originators (% average share of retained deal volume)
ABS
CDO
EU minimum retention (5%)
Source: IMF GFSR
7
6
5
4
3
2
1
0
MBS
Weighted average
%
2002
2003
2004
2005
2006
2007
2008
- More realistic to assume two types of intermediaries:
i) some with productive-investment opportunities that sell ABS;
ii) some without such opportunities that buy ABS and not only their AAAtranches¡¡
- Also, relax the assumption of ex ante symmetric information would be interesting
What I find less convincing
 In the model, the positive link between securitisation and leverage depends
on the volume of retained tranches.
 But, if retention is low (“O2D model”), that link weakens  in the limit, originators
create and sell assets with no impact on the size of their balance-sheets.
 On the other hand, investors in ABS may well end up raising their leverage.
Bank Leverage
100
Spain
Germany
UK
US
Distribution of the outstanding stock of ABS
France
Times
75
50
25
0
2000
2002
2004
2006
2008
2010
 (Net) originators seems less leveraged than (net) investors¡
What I find less convincing
 Is the paper’s liquidity contagion channel the most relevant??
An alternative based on asymmetric information would help us understand the
collapse of the secondary market of European securitisations, whose
performance has been remarkably good (i.e. a massive “lemons problem”)
Rating migrations: Spain, Europe and U.S
Europe
U.S
Aaa/AAA
Aa/AA
Baa/BBB
Bellow BBB
A/A
100%
100%
80%
80%
60%
60%
40%
40%
20%
20%
0%
Aaa/AAA
Aa/AA
Baa/BBB
Below BBB
A/A
0%
2008
2009
2010
Jun-2011
2008
2009
2010
Jun-2011
- Asset complexity, lack of transparency and a minimum degree of standardization
have exacerbated the asymmetric information, killing the EU secondary market
Conclusions
 Great paper, it helps understand some key links in the financial system that
are crucial in the origin, the propagation and the depth of the crisis.
 Some assumptions and modelling choices are not fully convincing but the
overall story is a credible one.