Friday, April 11, 2008

Why I think that originate-to-distribute will not survive.

I have referred a number of times to the core of the current crisis in the financial markets. This core is rather big and in my opinion standing on two prominent pillars. First is the Federal Reserve with its second mandate of optimal growth. I have referred to this mandate as bogus mandate because it represents the challenging recurrence of privatizing profits and socializing losses. The second, more direct to the point of the current sickness in credit markets, is the introduction of a new paradigm in term financial trans- actions. The originate-to-distribute model was designed to make term financial transaction infallible and replaced the old credit risk-to-maturity risk model. It did not withstand the test of the market place.

A smarter man than I am, Paul Volcker, said in his keynote speech in NY: "The bright new financial system for all its talented participants and rich rewards has failed the test of the market place."

Ben Bernanke still believes that the origiante-to-distribute model will "remain an important component of our system of credit provision". He is either ignorant of the facts or plain stupid. Both options are very disconcerting.

Here is why I do not think that the originate-to-distribute model will survive:

  • Regulators will step in and (figuratively) peek over the shoulder of every trading desk and every investor. This will drive up the cost of doing business.

  • The compensation costs of highly specialized personell in rating agencies and auditing firms will drive up the cost even further.

  • In the future investors will demand a higher risk spread. While the spreads will come in for conventional credit trasactions they will stay elevated for this type of business.

  • Most private lenders already ceased to exist or strongly reduced business in favor of GSEs and the like. The lack of competition will drive up the cost of business.
The originate-to distribute model was designed to lower the risk and consequently also the costs for all types of market participants. In the future the costs will most likely be significantly higher and render this new paradigm uneconomical.

source: Addressing Weaknesses in the Global Financial Markets: The Report of the President's Working Group on Financial Markets
Ben Bernanke

read also: Bernanke - another speech

read also: Paul Volcker - a real central banker

read aslo: Alan Greenspan - the charade continues

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