reading material on ongoing financial crisis
Prasad Chodavarapu
genesis of the problem to impact on india due to FII outflows. You can
read the articles at http://www.frontlineonnet.com/.
In addition, here's an extract from a must read article that was
published about an year ago in financial express (see
http://www.financialexpress.com/news/when-it-goes-wrong.../220607/0),
when Northern Rock, the first major bank to be hit by the sub-prime
mortgage crisis, went bust. This article is in turn an extract from
"The Promise and Perils of Credit Derivatives, by David Skeel and
Frank Partnoy, University of Cincinnati Law Review, 2006"
By the way, the word "Securitisation" used below refers to treating of
mortgages (home loans) as if they are commodities that can be traded.
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Until the early 1980s, finance hewed to an 'originate and hold'
model. Banks generally held loans on their balance sheets to maturity;
some debts were sold on loan-by-loan, but this market was small and
lumpy. This began to give way to an 'originate and distribute' model
after America's government-sponsored mortgage giants issued the first
bonds with payments tied to the cash flows from large pools of loans.
Wall Street built on this innovation, and securitisation took off
soon after, then paused before exploding in the 1990s (see chart 1).
It was given a lift by America's savings-and-loan crisis, which
encouraged mortgage lenders to jettison their riskier loans, and by
new technologies, such as credit-scoring, that facilitated
loan-pooling. Around 56% of America's outstanding residential
mortgages were packaged in this way, including more than two-thirds of
the subprime loans issued in 2006. Thanks largely to securitisation,
global private-debt securities are now far bigger than stockmarkets.
Banks have come to see securitisation as an indispensable tool
(see chart 2). Global lenders use it to manage their balance sheets,
since selling loans frees up capital for new business or for return to
shareholders. Small regional banks benefit too. Gone are the days when
they had no choice but to place concentrated bets on local housing
markets or industry. Now they can offload credits to far-away
investors such as insurers and hedge funds, which have an appetite for
them.
Michael Milken, of junk-bond fame, called securitisation the
'democratisation of capital'. Studies suggest that the explosion of
this 'secondary' market for bank debt has helped to push down
borrowing costs for consumers and companies alike. There are other
'systemic' gains, too. Subjecting bank loans to valuation by capital
markets encourages the efficient use of capital. And the broad
distribution of credit risk reduces the risk of any one holder going
bust.
Even in the midst of turmoil, it is hard to find a banker,
regulator or academic who wants to see the clock turned back. But the
crisis has exposed cracks in the new model that were hidden or ignored
during the credit bubble. The three most glaring are complexity and
confusion, a fragmentation of responsibility and the gaming of the
regulatory system.
Rayudu
Dear Prasad garu,
Thanks for the info.
If we go slightly deeper into the issue, it can be seen that the issues were addressed and a disclosure mechanism was recommended by international regulatory bodies long back. It is an enigma as to why the US govermnent and Fed allowed the "benign environment of leveraging" was allowed to continue for a long time after the receipt of the recommendations.
We have to continue this discussion.
regards,
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