Emerging markets, meet subprime mortgages
A new World Bank working paper called The Sub Prime Crisis: Implications for Emerging Markets makes an argument that the world may not quite be ready to hear, at least not so soon after the implosion of Wall Street. Authors William Gwinner and Anthony Sanders delicately explain in the abstract that "[i]t is possible to extend mortgage lending down market [in emerging markets] without repeating the mistakes of the subprime boom and bust." You don't have to start worrying about this question quite yet, though. Subprime mortgages still seem to be pretty rare in emerging markets:
[E]merging markets have been slow to move down market with mortgages. Mortgage lending is typically less than 20 percent of GDP in emerging markets, while it ranges between 40 and 100 percent of GDP in developed countries.
The authors lay out a lot of "lessons learned" that could help guide policymakers in emerging markets. Perhaps it would make good reading for policymakers in the U.S. as well!
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There is a need of clarification. There are always possibilities of making very prime mortgages to the subprime sector, as it has been done for many many decades in the world. Our current problems are derived solely from lousily awarded mortgages to the subprime sector. Those simple and transparently lousy mortgages would not have gone anywhere or created any dangers had it not been for the AAA wings given to them by the credit rating agencies.
In May 2003 and invited to say some words during a workshop arranged by the World Bank for bank regulators on assessing, managing and supervising financial risk I told the regulators, "I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit rating agencies. This sure must be setting us up for the mother of all systemic errors."
In a letter to the Editor of the Financial Times published May 11, 2003 I said “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds".
I was an Executive Director of the World Bank 2002-2004 and before, during and after that I have always alerted on the dangers of giving the credit rating agencies too much power. That the credit ratings are private companies has nothing to do with the market operating, since for all practical purposes they are only outsourced government agents.
My warnings were always completely shut-out by the financial department of the World Bank. Now, when I read this document I can only conclude that what is said there can only dig us deeper into the hole, making us and the markets again trust the credit rating agencies, “now they finally have got it right!”; so that even more will follow them over the next probably even more dangerous precipice.
The only real sensible thing to do is to reduce or hopefully eliminate the influence of the credit rating agencies over the markets, but not a word is referenced by the World Bank about that. Is it that the influence of the credit rating agencies over the World Bank is also too big?
Posted by: Per Kurowski | Sep 28, 2008 6:25:42 AM
Per, thanks for the comment. While credit rating agencies (CRAs) clearly contributed to the subprime crisis, they are only one piece of the puzzle. Perhaps delinking their payments from the issuer of securities would be a good first step in fixing this problem. From page 21 of the above-referenced paper:
...the rating agencies may also suffer from the incentive structure inherent in their business model...a potential problem surfaces when the issuing investment banks pay for the ratings, in that a ratings agency could give favorable ratings in return for repeat business.
Posted by: Ryan Hahn | Sep 29, 2008 11:57:44 AM