Thank you Gillian, much appreciated.
a) What percentage did banker's in the UK put aside before the introduction
of this new method (Credit Derivatives)?
Under the Basel regime, bankers needed to put aside 8 per cent of the total
value of any investment grade loan as reserves, irrespective of credit
quality (ie £8 for every £100). Once they discovered how to sell part of
those loans on using direct loan sales, or to sell the risk of that loan
going into default by entering into credit default swap contracts with
others, they did not need to put that whole £8 aside any more. Exactly how
much they did need to put aside varied according to how they structured the
deal but it was often as low as £1 or £2. What that meant was that banks
were essentialy able to make far far more loans than before. In the case of
Northern Rock, its own figures showed that it could make 3 to 4 times more
loan, per unit of reserves, than it had before it emrbaced securitisation
and credit derivatives technology.
b) What was our FSA (Financial Services Authority) doing whilst all this
was going on?
Not much. The FSA - like almost every other regulator - thought these
innovations would make the system safer than before, by spreading risk
around. That was the conventional wisdom that went almost unchallenged by
regulators and bankers - and generally ignored by everyone else, who didnt
care why credit was so plentiful and cheap, as long as it stayed that way.
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