Erenlai - Felipe Lozano
週四, 25 九月 2008 21:00

Human Capital Contracts for Asia

During the last summer I conducted research on the viability of the implementation of Human Capital Contracts in a developing country. As I am Colombian and  was familiar with the information available, the obvious start was to focus on my country. However, as I have been living in Asia and have been in contact with developing countries in this part of the world, I would like to develop a similar analysis here. In this article, I try to explain to Asian readers what Human Capital Contracts are; maybe some readers will want to follow me or join in the research presented here.

週二, 01 九月 2009 21:51

The Good and Bad of Securitization

 

The media is still debating over the consequences of the financial crisis that was triggered by financial instruments and lack of regulation. Some people point out to the underlying ethical issue. Given that human beings are prone to mainly pursue their own interests, there must be some regulatory institutions ensuring that self-interest is controlled and used for the effective creation of wealth.

It would be a mistake to consider that economic theory did not predict the 2008 crisis. There was a clear problem of asymmetry of information, described by the theory, as well as conflicting incentives for banks and for investors on securitized assets. Some banks were heavily exposed to the badly regulated, and very risky securitized assets. There were no clear rules governing these new markets.

The intertwined markets that together compose today’s economies are all subject to the trends governing globalized financial markets. When giant institutions began to fail, investors lost confidence and migrated to more liquid assets. Banks, afraid of runs on their deposits, which started to happen in several places, wanted to keep liquid assets, and did not want to take on more debt nor issue new credits. Finally, companies going to their banks for normal financial needs had their credit applications denied and often fell into deep troubles, with dire consequences on the job market.

As a consequence, many people might have already forgotten of the benefits of securitization and of the fact that access to housing has been greatly increased thanks to its use, which started 20 years ago. How do securitization benefits work? First, it comes from diversification: Financial theory argues that under normal conditions the probability to fail in one investment is higher than the chance of failing in two investments at the same time, given that both are not completely correlated. Popular knowledge has its own way of labeling this phenomenon: “Don’t put all your eggs in the same basket”. Moreover, risk is something that can be sold in the market and it also can be shared among a greater number of investors who will share the losses, thus diluting them.

If I have a mortgage transaction and I am the only possible investor, the risk of default is very high: if I lose my job; the whole security of my loan is in default. But if there are one thousand people in the same security then the chance of having all of them jobless is very small, even in today’s situation. Something similar happens with banks: if they can share the risk of issuing a loan among a greater number of investors through securitization and the sale of grouped mortgages, they will charge a lower interest rate, as the risk perceptions is lower. Everybody is a winner.

But responsibilities need to be clearly delimited, and penalties in case of misinformation should be specified as well as monitoring institutions. When banks started to lend money to very risky people, because they knew they could get rid of the loan selling it to an investor thousands of kilometers away, they were undermining the confidence in the system as a whole.

What was needed? An efficient and clear set of rules and a regulator capable of making the parties commit to their contracts. But the aforementioned does not mean heavy bureaucracies. The regulation has to be set by a group of specialists explaining to the parties the extent of their commitment and the implications for each of them.

Right now, I am involved in a research project for an institution called Lumni present in Chile, Colombia, Mexico and the US, which is helping people access to higher education and finance their studies by the means of grouping and hopefully in the future through securitization. Lumni, which has been chosen as one of the Top 25 Most Promising Social Initiatives, has already financed more than 200 students that probably, otherwise, would have abandoned their studies. It means that securitization can be a tool for promoting humane and equitable development, provided mechanisms and objectives are clearly defined. A new understanding of the limits and the social advantages of securitization might be a valuable lesson to be drawn from the crisis.

 

Photo by C. Phiv

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