Risk

One always hears quite a number of acronyms being thrown around when people are trying to hide some aspect bound to make Everyone scream in horror at some outrage, both by Those who would confuse, and Those who have no real grasp of the situation. The current financial crisis is an excellent Case in Point: Deriatives, CDOs, CDS, etc. The first element should be established that they are all basically Deriatives, whose best definition might be financial instruments which are designed to sell a Wind-Broke horse; i.e., a whole number of financial transactions which possess a poor performance rating are bundled together, and sold under deceptive circumstances as prime-value assets. Their principal function has always been to remove bad Performers from Commercial Banks Credit sheets.

Risk is risk, no matter how it is packaged. It is intrinsic to every financial transaction, and is determined solely by the successful fulfillment potential under the lending conditions. The later are always effectively generous to the Investors, and onerous to the Borrowers. The Investors are indifferent to the degree of difficulty of the lending conditions, and Borrowers have traditionally been less than candid about their repayment potential; Credit Rating agencies and Commercial Banks always delegated to referee the Transactions, and ensure that lending conditions are not usurious and that Borrowers can actually meet the repayment conditions inherent in the lending conditions. The essential element in Risk is that it is very palpable, and very destructive to Everyone if let loose.

The financial crisis came about because Investors wanted higher rates of Return on their investments, Borrowers wanted greater amounts of Cash than the adverse lending rates and their Risk performance would indicate, and Commercial Banks wanted a greater volume of Credit transactions which is the source of their own Profits. Commercial Banks possessed a real Problem which prevented an expansion of Credit, their mandated requirement to maintain Cash Reserves, along with their required maintenance of unresolved Credit transactions on Publicly-reviewed Accounts. They thought on the matter, and came up with a Proposition which pleased Investor, Borrower, and themselves; they would bundle great amounts of Debt, and sell this debt as Securities on the open market. Everything was great, or was it?

Risk being Risk, it was still there and based upon the Borrowers’ effective ability to repay according to the lending conditions of the loans. Sold Securities could be withdrawn from the Public books, by claiming they were Assets after being sold, not Debt at all. Deriative sellers could offer higher rates of Return to Investors because of a supposed spread of Risk across a wider range of instruments, something which this Author does not understand, or actually approve. Commercial Banks found the deriatives to be a Godsend, as they regenerated their Cash Reserves, and allowed for the issuance of more and greater loans to Borrowers, who supposedly found greater capacity to repay under the stipulated lending conditions. Everyone was happy, Investors could enroll their Cash assets at high reward, Borrowers could get an easy extension of Credit, and Commercial Banks could expand their lending base, making good Profits. It was perfect, except that the lending conditions started to intervene, Investors had utilized all their ready Cash, and Commercial Banks were forced to purchase the new Securities from each other simply to get them sold. The Music stopped, and there were no chairs to sit on! lgl