Partner
RSD Solutions Inc.
There is a very interesting article in the Saturday, November 16, 2007 Globe and Mail newspaper titled “The Black Box Explodes”1. The article outlines in a very clear, readable and succinct form the events leading up to the Asset Backed Commercial paper (ABCP) credit crunch that occurred in Canada this past summer and for which the effects are still being keenly felt in the economy at large. As the title suggests, the culprit for the credit crisis is the “Black-Boxes” of credit instruments known as CDO’s (Collateralized Debt Obligations) and SIV’s (Special Investment Vehicles) created by bankers and other financial types.
It is hard to argue against the suggestion that CDO’s and SIV’s are “Black Boxes” (BB’s). In fact as one who was a player in the markets creating the underlying structures and also as one that currently conducts training programs for specialists on these structures I too have to embarrassingly admit that I do not understand all of the various structures. Even worse, for many of those that I do understand, I still do not have the knowledge or the ability to accurately and objectively price the structures. Perhaps there are those smarter than me who can, but I have yet in my travels to run into them.
Having said that, are BB’s really all that bad? After all we encounter many different BB’s in our daily lives that we do not fully understand. For example I am sitting at my laptop typing out this blog without the foggiest idea of how my computer gets my (clumsy) tapping of keys into words on a screen and then through the invisible internet into your computer – at which point you see them on a computer screen that I suspect you also have to treat as a BB.
Let’s take a different analogy. I suspect that the proportion of people who understand how their anti-lock braking system detects a skid and kicks into action is less than 0.01% of all drivers. However I suspect that no one has ever refused to take a drive in a car because they did not understand anti-lock brakes.
The point I am trying to get across is that not all BB’s are bad. We depend on many BBs to efficiently and more pleasantly live on a daily basis. It is the same with CDO’s and SIV’s. While it is true that they are BB’s, that does not mean that they are all bad. For example, the securitization techniques (which underlie CDO’s) have allowed banks to create a wider variety of mortgages at lower mortgage rates that have led to more people than ever owning their own homes. The same goes for car loans, credit card loans, home appliance loans and the such that have allowed consumers to increase their standard of living at a faster pace than would have been possible even 15 years ago. To paraphrase “Martha”, these are “good things”.
[1]“The Black Box Explodes”, by Boyd Erman, Jaquie McNish, Tara Perkins and Heather Scoffield, The Globe and Mail, November 16, 2007.
