TRANCHED: Don't bash the CDO bankers
Today's the day. An assortment of academics, anarchists and middle class agitators are marching on the City. Whether the march is a peaceful protest against banking bailouts or a violent attack on the world's financial centre remains to be seen.
The protestors are targeting all bankers, regardless of whether they work in M&A or securities settlements. However, in more discerning circles one breed been singled out for blame more than any other: structured Credit bankers and more specifically CDO structurers.
Confessing to being an ex-CDO structurer often leads to silences in conversation. In some cases it leads to ill-disguised resentment. The CDO structurer is now the lowest of the low. There is an almost mythical belief that he or she had the power to bring the entire financial markets crashing down.
The truth, as always, is far more complex.
To understand the fundamentals of what went wrong, it is first necessary to understand how thirst for leverage corrupted the way banks had done always business. Securitisation (ABS, RMBS, CMBS, CDOs) offered a panacea to the financial markets, a way to transfer risk away from bank balance sheets, tranched to meet the different risk appetites of investors.
The staid business models of banks could be turned on their heads, the model of taking deposits and providing loans to customers who were known and trusted was old fashioned and outmoded. The entire concept of risk and return was being revolutionised, if loans could be written, pooled and securitised within a matter of weeks the "credit" risk equation that for centuries had driven the discipline of banks could be ripped up and thrown away.
Banks generated vast fee revenues structuring such deals. In turn, mortgage brokers and loan underwriters were incentivised to keep the flow of loans coming. Collateral managers selected structuring bank for their ability to provide the juiciest pools of assets.
However, the business of securitisation did not occur in a vacuum. The entire process was outlined under strict guidelines by regulators. Rules had to be obeyed and procedures followed. The portfolios to be securitised were subject to rating agency scrutiny and the tranching of deals relied upon projecting loan defaults and recovery rates which were themselves extrapolated from a period of incomparable stability.
In order to sell securitisation deals banks had to pump in their own money to show investors that they believed in the strength of the product. The term used was 'keeping skin in the game.' Off balance sheet SIV's were established to hold these assets, but when the music stopped the reputational risk of letting a SIV structure collapse meant they had implicit guarantees from the banks that set them up. So instead of risk transfer, banks ended up holding vast sums of assets that have now turned toxic and continue to pollute balance sheets across the globe.
Pinning the blame for this fiasco on all bankers is wrong. Pinning the blame on CDO professionals, almost all of whom are now suffering for their choice of profession, misses the scale of the problem.
Borrowers, brokers, bank management, regulators, rating agencies, politicians, bankers of every ilk, consumers and investors were all enjoying themselves much too much to reign in the excesses of the boom. The protestors may also enjoy themselves railing against the fabric of the City, but they are mistaken if they think they have the right target.
