Asset-backed securities: The key to unlocking Europe's credit markets? Bruegel Policy Contribution 2014/07, 24 July 2014

The European market for asset-backed securities (ABS) has all but closed for business since the start of the economic and financial crisis. ABS (see Box 1) were in fact the first financial assets hit at the onset of the crisis in 2008. The subprime mortgage meltdown caused a deterioration in the quality of collateral in the ABS market in the United States, which in turn dried up overall liquidity because ABS AAA notes were popular collateral for inter-bank lending. The lack of demand for these products, together with the Great Recession in 2009, had a considerable negative impact on the European ABS market. The post-crisis regulatory environment has further undermined the market. The practice of slicing and dicing of loans into ABS packages was blamed for starting and spreading the crisis through the global financial system. Regulation in the post-crisis context has thus been relatively unfavourable to these types of instruments, with heightened capital requirements now necessary for the issuance of new ABS products. And yet policymakers have recently underlined the need to revitalise the ABS market as a tool to improve credit market conditions in the euro area and to enhance transmission of monetary policy. In particular, the European Central Bank and the Bank of England have jointly emphasised that: “a market for prudently designed ABS has the potential to improve the efficiency of resource allocation in the economy and to allow for better risk sharing... by transforming relatively illiquid assets into more liquid securities. These can then be sold to investors thereby allowing originators to obtain funding and, potentially, transfer part of the underlying risk, while investors in such securities can diversify their portfolios... . This can lead to lower costs of capital, higher economic growth and a broader distribution of risk” (ECB and Bank of England, 2014a). In addition, consideration has started to be given to the extent to which ABS products could become the target of explicit monetary policy operations, a line of action proposed by Claeys et al (2014). The ECB has officially announced the start of preparatory work related to possible outright purchases of selected ABS1. In this paper we discuss how a revamped market for corporate loans securitised via ABS products, and how use of ABS as a monetary policy instrument, can indeed play a role in revitalising Europe’s credit market. However, before using this instrument a number of issues should be addressed: First, the European ABS market has significantly contracted since the crisis. Hence it needs to be revamped through appropriate regulation if securitisation is to play a role in improving the efficiency of resource allocation in the economy. Second, even assuming that this market can expand again, the European ABS market is heterogeneous: lending criteria are different in different countries and banking institutions and the rating methodologies to assess the quality of the borrowers have to take these differences into account. One further element of differentiation is default law, which is specific to national jurisdictions in the euro area. Therefore, the pool of loans will not only be different in terms of the macro risks related to each country of origination (which is a ‘positive’ idiosyncratic risk, because it enables a portfolio manager to differentiate), but also in terms of the normative side, in case of default. The latter introduces uncertainties and inefficiencies in the ABS market that could create arbitrage opportunities. It is also unclear to what extent a direct purchase of these securities by the ECB might have an impact on the credit market. This will depend on, for example, the type of securities targeted in terms of the underlying assets that would be considered as eligible for inclusion (such as loans to small and medium-sized companies, car loans, leases, residential and commercial mortgages). The timing of a possible move by the ECB is also an issue; immediate action would take place in the context of relatively limited market volumes, while if the ECB waits, it might have access to a larger market, provided steps are taken in the next few months to revamp the market. We start by discussing the first of these issues – the size of the EU ABS market. We estimate how much this market could be worth if some specific measures are implemented. We then discuss the different options available to the ECB should they decide to intervene in the EU ABS market. We include a preliminary list of regulatory steps that could be taken to homogenise asset-backed securities in the euro area. We conclude with our recommended course of action.

Iceland’s contested European Policy: The Footprint of the Past - A Small and Insular Society. Jean Monnet Occasional Paper 01/2013

Introduction. Iceland’s domestic politics and foreign affairs are undergoing drastic changes. After an economic crash, violent protests on the streets of Reykjavik for the first time in Iceland’s history contributed to the defeat of the government. The party system has been altered. A turn has been taken towards Europe after the United States left the island, first by closing its military base in 2006 and then by its clear stance not to assist the country in its economic difficulties. The former close relations with the superpower are unlikely ever to be restored. The EU membership application is placing severe constraints on political parties which are split on the issue and has put in jeopardy the unity of the first left majority in the Icelandic parliament, the Althingi. Society is in a state of flux after an unprecedented economic downscaling and the collapse of almost its entire financial sector – which had boomed rapidly beginning in the mid-1990s. The credibility of politicians, the parliament and the media is in ruins. Iceland’s smallness and its location on the geographical map – one could also say the geopolitical map – has had a profound influence on its domestic and foreign affairs. Iceland is closely associated with the other Nordic states and has adopted many of their domestic characteristics, with important exceptions. On the other hand, the country has come under American influence – geographically, it straddles the Mid-Atlantic rift – and has limited its participation in the European project. Its geographical location in the middle of the North Atlantic has led to a notion that the country’s culture is unique and should be protected by all available means. Politicians continue to play the ‘nationalistic uniqueness’ card with considerable success even though the country has been swept by globalization. Rapid modernization (which only really began in the Second World War with British and American occupations) and sudden engagement with the outside world (which only extended to the general public in the last quarter of the twentieth century) are still slowly but steadily making their mark on the country’s foreign policy. The country’s political discourse and foreign policy still bear the hallmark of the past, i.e. of a small and insular society This paper will address the political developments in Iceland since the 2008 economic crash and place it in a historical context. The aim is to understand Iceland’s present foreign policy and, in particular, the highly contested decision by its government in 2009 to apply for membership of the European Union. The paper is divided into five sections in addition to this introduction and the concluding remarks. First, it starts by explaining the importance in Iceland of a political discourse based on the concept of independence which dates back to the historical narrative of the settlement period. This section will also examine Iceland’s close relations with the other Nordic states – despite important differences between it and the others. Second, the paper will analyse the importance of the party system, i.e. the dominance of the centre-right in Icelandic politics, and the changed nature of the system. Third, it examines how Iceland further distinguishes itself from the other Nordic states in many important features. Fourthly, the paper analyses the country’s three main foreign policy priorities in the post-war period, i.e. extensions of the Exclusive Economic Zone, firm defence arrangements with the US and membership of NATO, and the drive for better market access for marine products – including a partial engagement in the European project. Fifthly, the paper examines how the country’s smallness, in terms of its central administrative capacity, has affected its domestic and foreign policy-making. The concluding section summarizes the main findings concerning the political and historical obstacles that the Social Democratic Alliance faces in its hard-fought battle to change the country’s European Policy.