– Thoughts on Strategy and Management

Do you blame structured products?

So far I have resisted the wish to comment about the ongoing sub-prime and financial crisis on this blog. I surely have an opinion about all this. However, so much has been written in this matter – analyses, comments, reports, more analyses, readers comment etc. I agree with many of them and disagree with others. Hence, I didn’t want to add to the large body of rephrased repetitions. Instead, I closely follow the coverage of this topic in the press and on the web.

After some months of reading, something starts to irritate me: Comments and analyses are full of the conclusion that something called ‘structured products’ is a major part of the problem – banks have created structured products which they hardly understood themselves. Similarly investors, rating agencies and regulators were not able to understand them. At least one reader who commented in yesterdays FT had a wider view of the picture. He states that not the structured products are to blame, but the unskilled use of them. That is a good thought, although it has the small flaw that I now wonder whether this unskilled use is due to a lack of skill or to obscurity of the products that nobody understands.

My point is: Where have all these analysts, columnists and commentators been one year ago? I remember that writings have been full of enthusiasm at that time. In my studies of Real Estate Investment Banking alone I heard so much enthusiasm from researchers and industry professionals (bankers, fund managers, lawyers …). We heard about

  • the merger of real estate and financial markets (well, they are both in turmoil now),
  • and about unprecedented opportunities to finance almost anything, i.e. to make a profit from junk property by financial engineering for investors and to make a profit from junk property financing by transforming it into structured products via securisation for banks.

We even had a top lawyer there who explained us the concept of securisation in great detail, including credit enhancement techniques. In the result, I found this structure not simple but not too complex to understand it at all.

I admit I was enthusiastic too at that time. To my excuse, I am not an analyst or newspaper columnist. Moreover, I was careful enough not to express this enthusiasm here on this blog. So what about all the others who now find it quite obvious that structured products are too complex to understand the inherent risk and that ratings of these products could not be trusted? From the hindsight it is easy to explain the causes of failure. It is far more difficult to keep a bit of scepticism when enthusiasm is on the rise.

This is my personal lesson from the financial crisis – the more enthusiasm there is about something, the more I should look out for the little flaws and inconsistencies that could break the great new trend.

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