On the Today program yesterday morning Merryn Somerset-Webb (editor of Money Week and former stock broker) was given the unenviable task of explaining “collateralised debt obligations” in just two minutes . Some of these mysterious financial wotsits linked to the American subprime mortgage market were blamed for falls on stock markets all around the world last week. So how do you invigorate such a somniferous topic? You talk about dodgy pork fillets and iffy sausages of course!
Read on for the transcript:
MSW: “The best way of thinking about this is to go right back to the beginning and think about what bank used to do. It used to be a bank lent you money to buy a house and then they kept that loan on their books and managed the risk themselves. Over the last few years as the derivatives market has grown and grown they’ve stopped doing that and they’ve started taking the loan they’ve lent-the money they’ve given you - chopping the loan into little bits and passing it on. The idea being that if they give lots of loans, bring them all back in, chop them up and then sell them on to other people, the risk of each loan is spread around the place.”
Sarah: “But of course it means your more likely to lend to somebody because you are not carrying the risk yourself”
MSW: “Absolutely. So that has meant that there have been many, many, many more loans so much, much much more risk in total, which is then supposedly being spread everywhere. And that is in some ways a good thing, in some ways a bad thing. If you think of it like for example having one pork fillet that you know might be off and lots that you think probably aren’t. Instead of just taking the one that’s off and either throwing it away or perhaps eating it yourself just to be sure, you chuck it into a sausage machine and then you make lots of sausages all of which might make everybody a tiny bit ill, and that’s basically what’s happened in this market. Does that make sense?
Sarah: “It does, I’m just wondering what’s going to happen now. We’ve got 30 seconds”
MSW: “So now, all these sausages out there and people are saying ‘I don’t know which sausage is going to make me ill, therefore I don’t want any of them’ . So suddenly we can’t put a value on ANY of these loans that are out there at all. Nobody wants them, nobody wants to buy them, nobody wants to tell you what they’re worth, and that has translated into the whole market as a credit problem, because these sausages -or loans - are used as security for other things”
Sarah:”And so everybody is infected and that doesn’t sound good long term.”
MSW:”Well I don’t know that it is good. I mean the idea of spreading risk is nice, the idea of spreading so much risk you don’t know where it is, is not nice.”
Sarah: Merryn Somerset-Webb, Thank you.
She must be right, today there’s news of an E.coli outbreak in Paisley due to some dodgy cold meat from Morrison’s, and the FTSE 100’s down 0.5%…
Updated Mentioning the E.coli seems in particularly poor taste now that someone has died I do hope the others infected are all right soon.
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