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Special Feature
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When local housing crisis becomes a global disaster
It only spells trouble for global finance and its auxiliary industries
The financial deepening of economies has become a major dynamic in highly developed countries. It is now spreading fast to emerging economies. The value of Global financial assets expressed as a ratio to global GDP was nearly 350% in 2006 (McKinsey 2008: 11), a ratio that jumps to 450% in a growing number of highly developed countries, from the US to Japan. More generally, the number of countries where financial assets exceed the value of their GNP more than doubled from 33 in 1990 to 72 in 2006. Securitising a broad range of types of debt is a key vehicle for this financial deepening. Government and corporate debt have been subjected to securitisation for several decades, with variable degrees of success. The extension of securitisation into consumer debt, including mortgages, took off in the 1980s in the US. Thus mortgage securitising is not new; indeed, the first mortgage-backed security was invented in 1977, though not necessarily widely used at the time.

While mortgage securitisation is not new, the current phase is an innovation that could play a critical role in the financial deepening of countries worldwide. The mark of this innovation is the extension of securitisation to include sub-prime mortgages and mortgages for low and moderate-income households. This feature makes mortgages available to a potentially vast global market, one that goes well beyond the most advanced economies and the middle and high-income classes. Extending mortgages to low-income households is a good thing that is when finance can really be a positive social force. But it is not a good thing if the main objective of such mortgages is actually to extract whatever small savings low-income households have and are likely to spend on housing. In my reading there are four characteristics whose mix spelled trouble for global finance and its auxiliary industries (accounting, law, public relations, et al).

One is that the target population is vast, especially when globally linked financial markets facilitate the deployment of these instruments in a rapidly growing number of countries. India and China, but also Eastern Europe, have underdeveloped mortgage markets but rapidly growing middle classes the prime combination for introducing this innovation. In many emerging economies it is foreign banks and financial services that are developing the mortgage markets (Moreno and Villar 2005; Gyntelberg and Remolana 2006). Secondly, the character of the innovation rests in good part on speeding up the numbers of mortgages granted and their bundling in order to reach the necessary thresholds for sale in the capital markets. This changes the logic for granting a mortgage: the velocity of mortgage-bundling becomes more important than the credit-worthiness of mortgage-grantees. Thirdly, the low levels of financial deepening in many countries signal a large potential for the marketing of these mortgage instruments. From the perspective of finance, one measure of this potential development is the ratio of outstanding residential mortgage debt (that is to say, mortgage capital) to GDP in highly developed economies, for instance 70% in the US, but about 10% in each India and China.

For moderate and low-income households, investment in housing can be conceived of as a mechanism for concentrating whatever the small resources such households can command. What they have available beyond basic needs will go into securing housing. Thus a financial instrument that allows low and moderate-income households to acquire a mortgage, becomes a vehicle for extracting those funds, bundling them up into a financial instrument, and selling them in the capital markets. It also becomes a potentially powerful vehicle for the financial deepening of economies, especially in so-called emerging market economies.

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