Structured Finance: the Unknown Ideal

The last six months have brought American finance to the edge of the abyss. Mortals who, not so long ago, had seemingly achieved demiurge deal-making status are now experiencing their Götterdammerung. A single question now poses and imposes itself: what will the next six months reveal about our financial understanding? As always, only two possibilities exist. Either structured finance will recoil from the abyss and find its own-most soul, or else it will simply collapse back into the feudal regime known as corporate finance.

Structured finance is a beautiful thing, and the men of Wall Street love to fall in love with beautiful things. Unfortunately, given the current depth of our predicament, not to mention our inability to act rationally, we need less heat, less irrational passion and regulation, and more light, more transparency. The transition from corporate into structured finance is analogous to prior revolutions; it cannot be accomplished without a painful re-adjustment, in this case to the dynamic framework essential to a proper understanding of structured finance as opposed to the static model found at the heart of corporate finance. The rules of the game, i.e. those found in the pooling and servicing agreement and in the SPC documents, are not the imprisonment, the reduction of freedom they are thought to be. On the contrary, they are a formal liberation of the creative powers that lie concealed at the root of any commercial endeavor. Far from the problem it is now thought to represent, structured finance is rather a resolution of the apparently unsolvable dilemma pitting borrowers against lenders since time immemorial. So close, and yet so far!

The power unleashed by the dynamics of structured finance is like any other force. Properly handled, which only means understood, it can lead to prosperity and countless blessings to the common man. Mishandled as it has thus far been, it can wreak havoc on a monumental scale, at the very moment we thought it was safe to go back to the trading floor. How we move forward from here is how others will later judge our character. Success and failure move along the same dimension, the stochastic horizon lying at the edge of the outermost limit. We are now standing on the surface of the atomic sphere, forced into a decision point, a choice that must irretrievably determine the future of American finance for its own sake, i.e. for the sake of deal-making. So far, we have chosen not to choose, but time is quickly running out on our self-determination. Soon, someone else will choose for us and for sure, we won’t like the result.

We are the choices we make. This one is ours and ours alone.

2 Responses to "Structured Finance: the Unknown Ideal"

  1. interested reader   June 3, 2008 at 1:40 pm

    Partnoy and Skeel (U-Penn) clarify in their paper that although the mathematic techniques of CDO technology are sophisticated, they are still subject to the limitations of “garbage in, garbage out”. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=929747What we need is less garbage, securitized or not. What is the reality?U.S. Ratings Distribution: A Twenty-Five Year March To Junkhttp://www2.standardandpoors.com/spf/pdf/fixedincome/USRtgsDist25Yr02Nov2006.pdfIt’s not only structured finance, it’s broader.

  2. John L   July 2, 2008 at 11:26 pm

    I agree, "So close, and yet so far!" Dealmakers have gone to great pains to structure bonds with the many credit enhancement; yet what ultimately dooms these securities are the asset.Ultimately is were not the complexities of the deals that doomed them rather, it was the inherent credit quality of the underlying loans (are their obligors) that failed them.The complexity merely makes the deals opaque.