“The Economics of Structured Finance” by Joshu D. Coval, Jakub Jurek, Erik Stafford -A critical analysis-
This paper is about the working of the Structured Finance (SF) machinery and also investigates about the spectacular rise and fall of structured finance. It discusses the challenges faced by rating agencies, particularly examining, the parameter and the assumptions of modelling that are required to arrive at accurate ratings of structured finance products. An attempt is being made to have a critical analysis of the SF, the product as well as the process. At the start, an effort is being made to enquire in to the reasons for the birth of SF, Why SF? What were the other Financial Products lacking, which gave birth to the SF, what are the peculiarities of the product etc., and what needs does it serve. The concept of SF took birth primarily in the mid 1980s, basically for transferring risk and in way by-passing laws to create products for companies having unique financing requirements which were not met by the other popular traditional financial products in the market. The modus operandi is creation of complex legal and corporate entities. The transactions and the products of the SF are so complex, that they are not understood by the creators or the rating agencies, what to talk of the buyers. In fact in the given paper, an e-mail correspondence between two analysts at one rating agency has been quoted, where in one analyst expressed concern that, her firm’s model did not capture “half” of the deal’s risk, but that “it could be structured by cows and we would rate it.” It has also been mentioned in the paper that , the then-CEO of Citigroup, Chuck Prince, acknowledged that the cheap credit-fuelled buy-out boom would eventually end, but that in the meantime, his firm would continue to participate in structured finance activities (as reported in Nakamoto and Wighton, 2007): “When the music stops, in terms of liquidity, things will get complicated. As long...
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