In his annual speech, Callum McCarthy, FSA chairman, said he hoped there would be an improvement in what he deemed to be “a concerning lack of discrimination between different asset classes, and different institutions” cited as a factor which led to the impact of the US sub-prime mortgage market being greater than it should have been.
McCarthy said: “I would hope – and expect – that there will be increasing discrimination in the approach of those extending credit: discrimination between asset classes, so that it is recognised that there are asset backed securities which are wholly untainted by any association with the US sub-prime mortgage market; discrimination within the mortgage backed securities market, based on more informed assessment of the quality of the underlying assets; and discrimination between possible short-term profit reductions and the fundamental ongoing credit worthiness of those institutions which, although their profitability may be reduced, remain well capitalised and good credit risks.
“I would hope that those who are seeking either credit or investment will assist this process by being clear about their exposure to particular asset classes. It is in everyone's interest – including their own – that this should happen: that firms indicate their exposure, direct or indirect, to the sub-prime market; and specify the nature and scale of their investment in complex instruments, whose valuations I fear may remain subject to uncertainty for some time to come.”
He also said that clearer information needs to be accompanied by clearer analysis if the market is to become more fluid: “It is important to remind ourselves that our present problems of liquidity and – crucially - confidence, the severity of which we all recognise, are occurring against an economic background which remains benign.
“Our main banks are well capitalised – they have capital ratios which remain significantly higher than regulation requires; their return on equity is at levels which many competitors envy; while they may be subject to liquidity pressures, they have, with a single notable exception, coped well with these pressures to date. Hence, banks start from a good position to withstand the pressures to which they will be subject as what are global, not exclusively UK, issues are worked through.”
McCarthy also said that it was “incontrovertible” that there had been a change in risk appetite over the last three months: “We have moved from one abnormal state of affairs – too little risk aversion – to another abnormal state – too much risk aversion. It is hard to argue that there is a lack of global aggregate liquidity, but it is clear that this liquidity is not being distributed efficiently within the financial system.
It will, of course, be important that investors and lenders react intelligently to the information that is revealed and use the data to make informed decisions.
He concluded with a reflection on the need to improve liquidity in longer maturities. “[The Bank of England’s auction] could contribute to alleviating some of the problems of valuation and liquidity in important asset classes. I hope that, once eligible banks have gained access to funds which the Bank of England has made clear are being made available to alleviate the strains in longer maturity money markets, they will deploy them accordingly.”
