Alchemists once claimed the ability to turn base metal into gold. More recently, some bankers seem to have been claiming a similar genius, via the magic catalyst of securitisation. These bankers no longer perform their traditional role of lending on a prudent basis to good quality borrowers in the personal or corporate sector. Instead, they simply seek to lend as much and as quickly as possible, usually in areas that they do not understand. Their aim has simply been to generate significant commission income for their bank, and personal bonuses for themselves.
Henry Kaufman was the leading investment ‘guru’ of the 1970’s, with his correctly bearish views on the outlook for bond markets. He was even known as ‘Dr Doom’ as a result. It is therefore perhaps significant that his views have once again begun to receive wider attention. In summary, the background to his current thinking seems to be:
• The scale and scope of recent financial market expansion is unprecedented
• Traditional credit instruments have been joined by a long list of new ones
• These are often extraordinarily complicated and opaque in their pricing
As a result, Kaufman believes that now ‘firms and households alike often blur the distinction between liquidity and credit availability’ (my emphasis).
Kaufman’s concern is that this has led to debt being considered as an asset. He believes that the recent growth in liquidity, which has underpinned the whole private equity boom, has been almost entirely based upon this ability to ‘securitise’ one person’s debt into an asset on someone else’s balance sheet.
Last week’s credit market turmoil has brought Kaufman’s concerns into greater focus. Lenders simply refused to buy securitised loans from the banks financing the Chrysler and Boots deals. These therefore now remain on the books of the banks who underwrote them. And according to press reports, there is another $300bn of such loans in the pipeline, many without an obvious buyer.
Traditionally, when the credit cycle turned, bankers found themselves stuck with an increasing number of bad debts that would never be repaid. Securitisation was supposed to remove this problem, by offloading the credit risk to others. Now, however, some bankers seems likely to find themselves operating the traditional model once again, albeit unintentionally.
Kaufman’s concern will then be tested. Will the lenders find that, to misquote the final tragic scenes of Shakespeare’s ‘Othello’, ‘they have lent not wisely but too well’?
We may well be about to find out that at least some of these securitised loans, far from being golden ‘assets’, are about to become traditional ‘liabilities’ once again.