A generation has prospered from the wholesale transfer of risk through securitisation. Now it is paying the price
“THE medium-term outlook for the company is very positive,” declared Northern Rock's chief executive, Adam Applegarth, unveiling its first-half results in July. He spoke of a credit book that was “robust”. Who would have guessed that less than two months later Britain's fifth-largest mortgage lender would be fighting for its life, its branches besieged by customers demanding their savings back?
The run on Northern Rock is the most dramatic symptom of the contagion gripping the financial markets. Here was a bank that had grown rich from the innovations of recent years, using abundantly stocked wholesale markets to fund its lively growth, using those same markets to offload bits of its loan book as and when they became unattractive.But the very innovations on which Northern Rock thrived have savaged its business. The company does no lending to speak of overseas. Nevertheless, its fate was determined by the distant turmoil in America's mortgage market. When that spilled over into the securities markets, the money markets that Northern Rock had depended on for years dried up in a single day at the start of August.
The brave new world that enabled banks like Northern Rock to grow so fast is founded on “securitisation”—the process that transforms mortgages, credit-card receivables and other financial assets into marketable securities—and the innovation it spawned in “structured” products. This was a revolution that brought huge gains. But across the financial world investors and regulators are asking themselves whether it also brought costs that are only now becoming clear....MORE