I suppose you could also argue that the CFO's who exchaned equity for debt were the smart ones who realized it was a bubble.

The idea is this.You are a CFO and find that credit has become cheaper for you, while your business hasn't changed. So someone somewhere has, probably indirectly, decided you are a less risky person to lend to than he thought before. Perhaps he thinks the same of everyone else too, including subprime mortgage buyers.

There are two reasons why this could happen. Either the hedgies might be right, and the market has become better at spreading risk to people who can judge the risk and are willing to take it, and this better system has judged you reliable.
Or it is all an illusion or a scam, and someone has been suckered in giving you a cheap loan. The truth is probably somewhere in between.

If you, the CFO, believe the second because you know your company better than everyone else and wouldn't lend to it at those rates, you take the money and buy back stock. As long as the credit stays cheap, your profit per share is up, and if rates go up again and you can't refinance, you can always issues stock again and return to the old situation. Until then,, you are siphoning money from Merril Lynch to your shareholders, which is what CFOs are paid to do.

On the other hand, you could also believe that the cheap rates genuinely reflect the reliability of your company, and think 'there must be something in all that securization after all'. In that case, you also take the money, and invest it in your company. In this case, you have a problem when rates go up again, but when they stay low, your expanded business might create higher profits per share than the buy-back-CFO's.

I would say that to the extent that securization is a sound principle, this last behaviour is good: through the whole system, resources can be sent to the companies that can create most value with them.
The credit crisis shows that people overestimated how well the system worked, not that the system isn't doing anything at all.

 

The process of "securitisation" is too big, too integral to fail.

That's the author's view, but it's whistling in the dark, because, mathematically, fail it must (and it is failing as we speak) because the basis of securitisation is deficit. ie credit creation by credit intermediaries.

Corporations have become financially "hollowed out". (and also, I believe - as an aside - "hollowed out" in terms of "human capital" where the best, most creative and most innovative individuals simply will not put up with working for Corporations any more. But that is another story.)

Jerome and I are having an ongoing debate on this subject, and this has homed in on my view that the only solution is the "Equitisation" of the financial system.

ie to arrive at a position where the basic "Value Units" of exchange are based upon:

• Equitisation or Unitisation - through actual direct "ownership" of something of value; as opposed to

• Securitisation - through a claim by one entity over something of value "owned" by someone else.

Jerome suggested yesterday that the nature of this legal relationship is irrelevant. The implication is that the legal claim of "Equity" (whether using a Corporation, Trust, Partnership or whatever) is qualitatively the same as the legal claim of Debt.

I disagree. They are Chalk and Cheese.

IMHO there is all the difference in the world: Equity and secured Debt are diamatrically opposed legal claims over the same asset. A completely different polarity.

The key point is that a productive asset may have production adequate for a decent return on capital, without necessarily being sufficient for a return of capital.

Alternatively capital may be returned in the form of production (of, say, energy) without any return on this capital.

Equitisation - and not through using Corporations - offers a solution for an otherwise intractable problem.

I'm going to concentrate on a different line of that quotation than the one you bolded...

European Tribune - RLQD: On changes in credit for companies

The process of "securitisation" is too big, too integral to fail. That may be true, but by the time this crisis is over, it is going to be a lot more tightly regulated - not least as pro-cyclical Basel II capital adequacy rules are implemented. That could change the supply of credit.

What exactly does "pro-cyclical capital adequacy rules" refer to, and what effect are these pro-cyclical rules going to have on the business cycle?

We have met the enemy, and he is us — Pogo