What were you doing 10 years ago?

I was working in the structured credit team at Moody’s rating structured finance products issued out of Europe; specifically leveraged loan CLOs, which fared pretty well throughout the crisis. At the same time, I interacted regularly with colleagues in New York who were rating a substantial volume of transactions backed by U.S residential assets that were at the root of the crisis.

How did you react when you heard the news about the collapse of Lehman Brothers?

I was in a position where I was able to witness from close-up the shift in views around CDOs backed by US RMBS tranches, which turned out to be some of the most toxic products of the crisis. But while I had the technical knowledge about how CDOs were supposed to work I was not particularly familiar with the US mortgage market or specific features of mortgage loans such as adjustable rate mortgage (ARMs) that ultimately caused difficulties for sub-prime quality borrowers.

When Lehman defaulted, some very deep problems with the US mortgage market had been evident for a year and a half; it had become common knowledge. The question I had at the time was how quickly this would contaminate the global banking system, the real economy and possibly the sovereigns? In that period of autumn 2008, we had already seen what happened with Bear Stearns and AIG.

It was also very clear that Lehman Brothers was in deep trouble, but very few anticipated it could be left alone to fail. From that perspective, the bankruptcy came as a surprise.

After the news broke, my immediate thought was if Lehman can go bust, what about Morgan Stanley, Goldman Sachs? CDS in some names were reportedly trading ‘upfront’ i.e. their expected risk of default was so high that investors had to make significant up-front payments to buy protection. The thinking was that if the market under-estimated the possibility of Lehman defaulting, what about the next one?

What were the stand-out moments for you as the global financial crisis broke?

The deep interaction of the financial system was a hard wake-up call. Lehman highlighted how inter-connected the financial system was. Seeing the magnitude and impact of the degree of inter-connectedness was a shock.

In the ensuing 10 years, what has fundamentally changed?

Since the crisis, the structure finance market has come under intense scrutiny from all sides, including from investors and regulators. A lot of measures have emerged impacting all market participants in structured finance, but they have been applied in a very generic and standardised way. I suppose that’s understandable: since regulators had discovered a big weakness in the system, they felt compelled to apply restrictive measures to all forms of structured finance. But what that has created is a very heavy legacy for the European securitisation market, which when I look back had fared pretty well.

The crisis put a spotlight on structured finance, but it has led to a regulatory framework that is over-penalising the European market.

For example, I was responsible for the 200 leveraged loan CLOs rated by Moody’s. Not a single investment-grade deal defaulted. Some of the Triple As shifted to Double A but bounced back pretty quickly afterwards. It was an example of an asset class that did very well, thanks to strong incentives and alignment of interests between transaction parties and investors.

If you look at the entire European structured finance sector and some of the consequences of the crisis, there are positives: investors have understood they had to dig deeper in their analysis, while the market needed more transparency. The negative aspect has been the very restrictive regulatory response applied with no distinctions made for Europe.

That said, the intense regulatory pressure on structured finance has already started to erode as policymakers seek ways of funding the real economy and accept that structured finance can be a tool to facilitate that. Authorities in Europe have tried to re-open the structured finance market in a solid and virtuous way to create channels to fund the economy. Done properly i.e. with transparency and solid alignment of interests – which frankly is the case with many securitisation in Europe – securitisation leads to relatively robust products.

What are the key risks today as you scan the horizon?

There are some macro and country-specific risks out there which if they crystallise will impact structured finance transactions: disruption to the UK residential real estate market, macroeconomic performance in Italy; geopolitical issues in Spain around Catalonia, for example.

I have some concerns about the financing that comes via direct lending or other forms of alternative finance, which are sometimes repackaged into structured finance products. I see a lot of investors investing over longer and longer maturities in less and less liquid assets in order to capture spread. It doesn’t make sense long-term.

If you take a step back, how does a crisis start? It begins innocently with a surge of healthy optimism among investors. Optimism turns then turns overtime into over-confidence supported by bankers creating more aggressive products. Before you know it, the accompanying boom happens to last a lot longer than you thought it would. Then comes a sudden specific event which triggers a shift in the risk view.

This is where ultra-low interest rates lead us. Once the risk view shifts and liquidity dries up, we could be faced with some difficult moments. And at the monetary level, when the next crisis breaks, I’m not sure central banks will have many tools left at their disposal to stabilise the system.