3 comments on “Timmy elsewhere

  1. I didn’t click through to the Fed paper, but there seems to be some confusion of individual risk (one loan), portfolio risk and systemic risk.

    Securitisation was touted as spreading and so diminishing risk. I doubt that the buyers were aware that it was used by the banks to originate ever dodgier loans.

    But that’s what happened in practice. That measuring risk reduces risk is a common delusion shared by mountain guides, yachtsmen, miners, all sorts really.

  2. “That was rather the point of it, to spread risk and thus allow more to be taken.”

    The problem is how you define more.

    To the regulators they probably expected it meant more loans of the same risk profile – banks wouldn’t take undue risks would they? To the mortgage banks it meant loans that were more risky.

  3. Tim that was not the main point of it. The idea of securitisation was to find buyers for credit risky assets which only a few wanted to hold.

    Take for example $1bn of borderline investment grade loans. These are too risky for traditional credit funds, far too risky for insurance companies and not risky enough for hedge funds. There’s a lack of demand.

    So with securitisation you create structural subordination. You issue 3 bonds which state that they get the income (and risk) from the $1bn loans but that the $400m face value first bond gets paid first, then the $400m facevalue bond gets paid second and the remaining $200m bond gets paid last.

    The rating agencies based assign a AAA rating to the first bond, a A rating to the second bond and a junk rating to the third bond. So then the insurance company buys the AAA, the credit fund buys the A-rated bond, and the credit hedge fund buys the junk bond.

    Securitisation is the magic process of matching risks to risk appetites. And it usually works – at least when the underlying loans are not riddled with fraud a la subprime.

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