Fear and Loathing, and a Hint of Hope

Not all is lost for the structured-finance business. But it faces further discomfort before it can start to recover some of its past sheen.

As gags go, it was cheap. But irresistible. As a banker from Citigroup placed his chips on the roulette table, a watching wise-guy sniggered: “There goes another $15 billion.”

Even though it was held (as usual) in Las Vegas, this year’s conference of the American Securitisation Forum (ASF), between February 3rd and 6th, was a subdued affair. First staged only in 2004, the event has become a mecca for those whose job it is to spin mortgages, credit-card debt and other bread-and-butter financial assets into tradable securities. But this time attendance was down—and tension up, as the neck-masseuses in the exhibit hall could attest. Black humour and self-deprecation replaced the self-congratulation of past years. John Devaney, a hedge-fund manager who had to sell his 142-foot yacht, Positive Carry, and his Gulfstream IV after making bad bets on mortgage bonds, told an audience: “I’d like to thank the market for dealing me a direct hit. As a trader if you don’t get sucker-punched every once in a while, you don’t understand what risk is.”

You might suppose that meeting in America’s gambling capital would provide symbolism enough. But the conference Super Bowl party had plenty more. It was hosted by Countrywide, a big, troubled mortgage lender that has had to fall on the charity of Bank of America. And, as the guests digested the dramatic ending of the New England Patriots’ long winning streak by the New York Giants, they may have sensed an uncomfortable parallel. After a quarter-century of growth that turned structured finance from a capital-market cog into an engine of growth, their business has been buckled by the crash in subprime mortgages and the successive blows throughout credit markets. Worse, some blame securitisation for causing the pile-up in the first place.

The limits of gonzo finance

Securitisation has greatly enhanced the secondary market for loans, giving originators, mainly banks, more balance-sheet flexibility and investors of all sorts greater access to credit risk. Both have embraced it. By 2006 the volume of outstanding securitised loans had reached $28 trillion. Last year three-fifths of America’s mortgages and one-quarter of consumer debt were bundled up and sold on.

Along the way, banks cooked up a simmering alphabet soup. The ingredients included collateralised-debt obligations (CDOs), which repackage asset-backed securities, and collateralised-loan obligations (CLOs), which do the same for corporate loans, as well as structured investment vehicles (SIVs) and conduits, which banks used to keep some of their exposure off their balance sheets.

The breakneck growth of this business went into reverse last summer, when it became clear that defaults would undermine the structures built around America’s mortgage markets. So tarnished has the subprime-mortgage market become, because of shoddy loan underwriting and fraud, that investors are likely to shun securities linked to it for months if not years. Securitisation of better-quality “jumbo” mortgages—too big to be bought by government agencies—is also at a near-halt. “Mortgages were traditionally seen as very safe assets. Now all but the very best are stamped with a skull and crossbones,” says Guy Cecala, of Inside Mortgage Finance, a newsletter.

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