Everything Has A Limit

Poker, economics, and personal crises, a three-for-one deal

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Spammer does me a favour
peterbirks
I got a whole load of "replies" to very old posts tonight. They were, of course, all exactly the same. And whatthe point is in replying to posts that a blogger made six years ago, I really don't know.

However, in this particular case, one of the posts was quite interesting. I wrote this on June 28th 2006, more than a year before the first signs that things were going wrong with the US mortgage loan book, and more than two years before Lehman Brothers collapsed.

Here's what I wrote, with the cliff note paragraph right at the bottom:
An announcement went out this morning from Sampo, a Finnish bank. No-one will pay much attention to it. Here's the full text.

Sampo Bank plc, part of the Sampo Group, will securitize approximately one billion euros of the exposure of corporate loans in its balance sheet. The reference portfolio consists of the loans of over 600 Finnish companies. The loans will remain in Sampo Bank's balance sheet and the arrangement will thus not affect the agreements between the bank and its customers in any way. This is a mechanism by which Sampo Bank can adjust its credit risk profile and release capital for future growth.

Securitization will be implemented by a company established especially for this purpose. The company will issue bonds whose final return will be dependent on realized credit losses from the reference loan portfolio, and offer them for subscription by investors. The company will compensate credit losses arising for the bank on the basis of a credit derivatives contract between it and the bank .

So what, you might think. And, indeed, the whole tenor of the announcement downplays any interpretation that this makes any difference at all. Its purpose, says Sampo, is to "adjust its credit risk profile and release capital for future growth".

But, therein lies the tale. This is what a number of banks are doing. In the old days, a bank was kind of a broker between depositors and borrowers. They didn't like being called brokers, but that was what they were. People deposited their money in the bank, and the bank lent it out. If they lent it to the wrong people, they were in a bit of shit. If they got into a lot of shit, then the depositors were in shit, because they might not get their money back. But it was in the interest of the bank to make prudent loans, if only because being an executive at a bank that goes belly-up because of bad loans doesn't look good on the CV.

Indeed, there is a current-day example of this. The Agricultural Bank of China theoretically has 25% "non-performing loans". In fact the figure is far worse than that, because local managers are lying to their regional superiors, who are lying to their national superiors. It's the old Stalinist five-year plan reports in action. Fucking up is not an option, so, if you fuck up, you might as well lie about it, because things couldn't be worse than if you told the truth.

Sampo's manoeuvre changes the rules of banking. What it has done is taken a billion euro of loans, and transferred the risk associated with those loans to another company, which sells bonds. Institutional investors buy these bonds (which can be spliced and diced into different tranches of assumed risk, paying different rates of interest) and, if the borrowers default, the institutional investors don't get their dividends. If things go very bad, they don't even get their capital.

But, and this is the point. The bank doesn't really give a shit. If the loans go tits up, they can point to the rates offered and the nature of the beast.

In other words, we enter the serious world of moral hazard. Sampo, by its own admission, has done this "to release capital for future growth". And what does that mean? Why, to make more loans, of course, which it can then securitize, in order to release even more capital "for future growth". What you have is a bank that seriously wants to lend money, in order to grow. Employed senior executives like to grow. They get higher bonuses, bigger cars, bigger desks in bigger offices with bigger-busted secretaries.

You would think that people would learn from history, from the Savings & Loan scandals of the 1980s in the US. But, well, 20 years is an aeon in financial services. It's going to take one almighty balls-up, a seriously massive default, before the institutional investors realize that perhaps allowing banks to lend money without assuming any of the risk associated with lending that money might not be the best idea in the book.



In other words, if it was blindingly obvious to me in 2006, why wasn't it obvious to the people who mattered? Because, quite simply, it was in their interest to ignore it.

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