Other Voices: Financial engineering causing widespread collateral damage, FT comment: Financial innovation itself is the problem, and how to deal with it, Fiscal, not monetary policies: Pimco`s Gross urges White House, not Fed to bail out homeowners, Gross sees time near for bargain-hunting in credit
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From Wouter B. ten Brinke, CFA, Theta Capital: How can we witness such violent moves in global credit markets while actual default rates are still at all-time lows and the global economy seems in pretty good shape? The answer is financial engineering.
Collateral damage
A critical driver of the recent sell-off has been liquidation of positions by leveraged investors of
various types: hedge funds, banks, special purpose vehicles, special investment vehicles and ABS
conduits financed with commercial paper. While the financial media mostly look at the subprime
exposures of top US investment banks, we are more worried about the implication for the more
traditional commercial banks, also in Europe. In fact, the ECB’s emergency injections of liquidity
into the banking system (accompanied by a large USD swap with the Fed) illustrate the presence
of a potentially serious liquidity issue. Core to the problem are the US-based asset-backed
commercial paper conduits (ABCP’s); vehicles that issue short-term debt instruments to invest
the proceeds in longer term and higher yielding mortgage pools. To guarantee liquidity towards
their commercial paper investors, many conduits have credit facilities guaranteed by large
commercial banks. Now that losses on the mortgage pools mount, the appetite of commercial
paper investors effectively evaporates and conduits will start calling these credit lines.
Through this transmission mechanism, financial institutions with no direct inves...................... To view our full article Click here
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