1October 2008

2Practically unknown to the general public before the “subprime mortgage” crisis, securitisation has become part of today’s media’s vocabulary. This technique, which involves transforming loan portfolios or real assets into securities (shares or bonds) available for any type of investor, is in fact the cause of the most serious financial crisis in history since the 1930s. Already, around 1,000 billion US dollars have disappeared after the decrease in the securities’ value, a sum much higher than the bursting effects of the Japanese financial bubble (780 billion US dollars loss of value) and the Asian crisis (420 billion US dollars). Nevertheless, financial markets are far from hitting rock bottom, judging by the recent collapse of Fannie Mae and Freddie Mac, the two giants in property finance.

Low success of debt securities in Asia

3The crisis had taken root in the American property markets before contaminating the global financial system. In the game of securitisation (the cutting of loan portfolios), the giant mortgage debt of American households was financed by funds coming from all over the world. American banks were able to underplay the risks of the borrowers’ default, by transferring them to the investors. In order to be able to lend more, mortgages were extended to households with a low credit value. These portfolio loans were restructured according to risk categories; securities of securities were issued so as to provide investors with a wide range of products and to give them the impression that the risk had disappeared. Therefore, it is almost normal that the shortcomings of these loans, which are most at risk – and most lucrative – referred to as “subprimes” have weakened the structure and induced financial collapse.

4Although the subprime crisis recently unveiled securitisation, this technique is not a recent invention. Created in Wall Street in the 1970s, it quickly spread to North America, then to Europe in the 1980s, before conquering Asia. During the Asian crisis in 1997, the IMF placed value on the merits of securitisation to “recycle” the large amount of bad debts that were suddenly accumulated in the region, with South Korea at the eye of the storm and Japan and Hong Kong being hit soon after. Securitisation then developed in major ASEAN countries, with Malaysia anticipating to provide securities through Islamic establishments. In spite of these efforts, however, the volume of these products remained far below the great investment potential in the region. Banks mainly had the upper hand over the “classic” mortgage. As for the other types of “securitisable” credits (consumer loans, high-risk mortgages, etc), the issuance of corresponding securities, the asset-backed security – ABS – only amounting to 100 billion US dollars in 2005 (two thirds of which came from Japan, Australia and Korea), that is three times less than in Europe and eight times less than in the United States. These products, moreover, ran a lower risk than their American counterparts and, with the exception of the Australian case, were traded mainly in the domestic market.

5The reasons for this lack of enthusiasm vary from one country to another, but in any case the weak development of securitised credit in Asia can only be welcomed for fear of the property development bubble bursting in this region, provoked by the spreading of securities throughout the entire planet. In light of property values in big Asian cities, the American market is fading into the background: with a loan limit of 417,000 US dollars by Freddie Mac and Fannie Mae, it is hardly enough to buy a small apartment in a big Asian city. Besides, the unequal risk culture and the strong opaqueness that make some Asian financial markets what they are, would certainly encourage the creation of speculative mechanisms and delay its reduction.

6Asia was, however, not spared by the subprime crisis. The Chinese and Japanese investors were even the main buyers of securitised debt in the United States. They cleverly moved away from the risky subprime segment, with 379 billion US dollars’ worth of loss registered in May 2008 by large global banks, the share of the Asian banks did not reach 5%. The majority of Asian capital was invested in Fannie Mae and Freddie Mac’s securities, reputed to be safe before the crisis. In June 2007, China and Japan held respectively 376 and 229 billion US dollars with these two establishments. Since then, the value of these securities has significantly been reduced. More generally speaking, the effects of the crisis had already compromised the Japanese revival and threatened to severely affect Chinese growth.

One securitisation can hide another

7There is another type of securitisation of which we spoke very little about during this crisis and which has nevertheless made significant progress in Asia recently: property securitisation. Its principle, identical to that of securitisation, consists of dividing the property portfolios into small parts (securities), to make investment accessible to any type of operator and to facilitate transactions. The most successful formula is the Real Estate Investment Trusts (REIT), which buys and manages buildings by raising capital at the Stock Exchange. The REIT securities issued by these companies are affordable, the share amount being 150 to 200 euros. This category of securitisation is, however, far from reaching the size of the previous one; its liabilities totals almost 600 billion US dollars, compared to 8,700 billion US dollars for the securitised debt.

8It is not surprising that the initial REIT funds were created in the United States, before arriving in Europe in the 1980s. They infiltrated Asia during the 1997 crisis, with the launch of the REIT funds in Thailand ending the stricken property market. This, however, was met with notable success in Japan, with the country taking the fourth share of the REIT market globally, in five years only (2001-2006). Launched at the same time as in Japan, the Singaporean REIT’s are ranked second in Asia, with 13 companies capitalising 13 billion US dollars (compared to 40 companies and 40 billion in Japan) in 2006. Hong Kong and Korea trail far behind.

9In Singapore and Hong Kong, property developers quickly understood all the interest that the REITs could provide them with, in order to invest outside of their territory. Singapore has become the main hub of REIT funds in South-East Asia (Indonesia, Malaysia and Thailand in particular), and, more recently, India, while Hong Kong has offered small investors access to property on the Chinese continent, with a high rate of return, but with risks attached to it. The first REIT funds invested in China, “GZI REIT”, was created by a Hong Kong investment company in late 2005 and invested in shopping centres in Canton.

10In Japan, until now, the securitised property investment subsidiaries of the Japanese industrial conglomerates, including Mitsui, Mitsubishi and Sumitomo alone make up 40% of the national capitalisation of the REITs. This is being invested in office buildings in the most prominent business areas of the country; the corresponding REIT securities were safe values until the subprime crisis affected this part of the market.

11The remarkable progress of REITs in Asia until 2007 are attributed to the low levels of interest rates that have plagued property development, like elsewhere. In addition, the emerging market offered great growth at the beginning of the 1990s when the REITs were already highly developed in North America and Europe. Moreover, the performances of the Asian markets reached their expectations, as the REIT securities offered returns on average by 2 points compared to the treasury bonds.

12Apart from their advantage as an alternative investment product, the REITs accounted for a new financial source for property developers, which can finance a major part of their property projects by raising funds at the Stock Exchange. These new practices have literally revolutionised the property profession. The standards published by national regulations to protect small REIT security shareholders have forced the investment companies to be transparent in their management and to standardise their methods of evaluation. Within a very short time, certified experts had to swap their old rule of thumb methods for estimating estate values compared to sophisticated techniques based on Anglo-Saxon models. There was the ridding of archaisms blocking lease contracts, similar to the chonsei in Korea, an up-front deposit paid by the tenant when the lease is signed, which equals half of the market value of the property, and which the tenant recovers when he leaves the premises.

13Securitised property is, however, far from only being advantageous. It deeply affects the dynamics of the property markets, by making them more unstable and volatile, as in these markets, which have become highly liquidised, the slightest movement is transmitted from one compartment to another, quickly affecting the healthiest of sectors. Similarly, the panic and euphoria affecting the property sector are repeatedly reinforced by the increased responsiveness of investors subjected to suspicious behaviour. The mimicry does not stop there. The REIT funds follow similar investment strategies, converging on the same narrow niches (shopping centres, offices or prestigious housing), resulting in an artificial rise in land values for some sites while the rest of the country is in decline. Such a phenomenon of an urban divide was recently observed in Japan, where the “satellite-centres” of Tokyo’s suburbs and the small provincial cities suffer as a result of an under-investment in property renovation, while major projects were becoming concentrated in the centres of large cities at the risk of generating a property boom.

14Will the subprime crisis result in at least an awareness of the dangers of securitisation in Asia? We cannot be sure that all the lessons learnt from the American debacle will be taken into account. History shows that financial markets have a short memory and that good resolutions made in times of crisis are soon forgotten when a new episode of speculative euphoria occurs.