Never blame securitization

Securitization offers many advantages to all participants in the marketplace. Derivatives decrease barriers of entry to a host of markets, increase potential diversification and customization, and enhance liquidity and hedging activities.

Securitization has represented a series of innovations that have brought about greater efficiency but the problem with innovation, almost by definition, is that they outpace the ability of the infrastructure, on both the private and public side, to sustain the innovation.

Now, the system is trying to catch up but we risk an overreaction that may limit the potential of securitization. Hopefully, an understanding that a return to securitization is crucial to economic recovery (by allowing banks to lend more through risk transference) will lead policymakers to resist any misguided populist sentiment.

The new products present challenges for risk managers and regulators alike. It also burdens operations, technology, and settlement systems in the process. In reality, every level of the financial system will need to continually adapt to changing risk and complexity.

Unfortunately, policymakers, almost by default, will always be behind the curve. Because an attractive fee is extracted at every stage of securitization, the agents, or intermediaries, will will always be prone to excesses. Innovation will always outpace the ability of the infrastructure to sustain it and securitization crises will be a recurring phenomenon in the new age global finance, you bet. But try doing away with it, you're only deepening the liquidity crisis.

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The Goldman heyday

What are we to make of Goldman’s Q1 results…? Making $3 b in as many months is indeed recession defying but how much of it is its own making in contrast to the near absence of competition – Citigroup, UBS, Lehmann and its ilk? The Economist says - To the survivor the spoils - and I can’t agree more.

Monday, after market close, Goldman Sachs Group, Inc. reported 1Q09 earnings of $1.66 billion or $3.39 a share, up from $1.51 billion, or $3.23 a share a year earlier. The results were way ahead of consensus estimates of a profit of $1.64 per share.

Higher-than-expected profit was mainly due to strong trading revenue. Of the first quarter net revenues of $9.4 billion, $6.6 billion (34% higher than its previous record) was the contribution from the company’s fixed-income, currency and commodities (FICC) group. High volatility (benefiting the Treasury markets and the Dollar), wide spreads in fixed income and reduced competition in the markets were the main reasons for strong earnings.

However, the areas outside fixed income and currency businesses showed weakness during the quarter. Investment banking revenues were down 30% year-over-year, due to the low activity in the capital markets. Asset management revenues also declined 28% to $949 million.

Again as the Economist says this windfall will likely dwindle soon. The firm may be scooping up market share at quite a clip. But the bigger picture is still far from pretty. Goldman and other survivors will benefit from the coming wave of debt issuance by federal, state and local governments. But dealer spreads are sure to shrink as markets normalise and those that have retreated return to the fray. This is likely to be offset only partially by a pick-up in businesses tied more closely to economic growth, such as advising on mergers and acquisitions.

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