On Securitisation (December 2008)

Once upon a time there was a field mouse.

Each day, before anyone else was awake, he would wake up and scamper up the Big Hill, further than any of his friends ever dared go. He liked to stop at the top of the hill to nibble at the wild blackberries and catch his breath. For there, stretched out before him, were acres and acres of wild mushrooms.

The first time he had ever reached the brow of the Big Hill and seen the mushroom field, he had found an old mouse with gnarled whiskers and thin striped boots resting on a stone. His eyes must have widened at the sight of all the mushrooms below, because the old mouse had chuckled and said

“Now sonny, if you’re going to go picking mushrooms, take my advice. You can’t just pick any old mushroom. You have to make a bit of extra effort, and find the mushrooms that are safe to eat. If you see a mushroom with nasty purple veins and oozing yellow puss, that’ll poison you. But if you see a mushroom that’s clear, it’s safe for you to eat.”

“I have to check every mushroom?” the mouse protested, “but that’s so much extra work!”

“That it is,“ said the old mouse. “That it is.”

Since then, every morning the mouse had run up the Big Hill. He didn’t want to get poisoned or poison his friends, so he carefully checked all the mushrooms, picked as many clear mushrooms as he could carry, and took them back to his field to sell. He did very well.

But today was different. Because today, on the brow of Big Hill, he came across a mouse with a Dick Wittington pouch and a slow, weatherbeaten expression.

“Where are you going?” he asked.

“I’m a traveller mouse,” said Wittington, “I travel. Here and there.”

“Do you want to buy some mushrooms?” said the mouse.

“I don’t eat mushrooms” said Wittington, wrinkling his nose, “and I can’t carry enough to sell ‘em one by one.”

The mouse wiggled a finger in his ear and gnawed at a blackberry, thinking. Suddenly, he had a brilliant idea. “I tell you what,” he said, “I’ve got lots of mushrooms to spare. How about I bake lots of them together into a pie, and sell it to you?”

Wittington looked confused.

“That way,” explained the mouse, “you pay me now for one mushroom pie. And when you meet other mice on your travels, you can sell the pie to them, and make money for yourself.”

Wittington said he didn’t see why not, and then stretched out on the stone for a nap. So, rubbing his paws together in anticipation, the mouse picked lots of safe mushrooms, ran home, baked them into a pie, sold it to Wittington, and went to sleep that night a very happy mouse.

This went on for many months. Soon he was no longer picking any mushrooms to sell himself. Rather he was picking the mushrooms, baking them all together into pies, and selling all the pies to Wittington to sell on to mice from other fields.

One day, stopping at the brow of the Big Hill to catch his breath, he looked down at the field of mushrooms ahead of him. ‘The funny thing is’, he thought to himself, ‘now that I don’t sell any of the mushrooms myself, checking every single mushroom feels like a real hassle. Would it really be so bad if I don’t check them? After all, the poisonous mushrooms and the safe mushrooms all look the same when they’re baked in a pie – nobody will be able to tell the difference. And besides, once I’ve got the money from selling the pies to Wittington to sell to other mice, it makes no difference to me if some of the mushrooms in the pie are poisonous…’

And so, he filled the pies with a mixture of mushrooms – some safe, some poisonous – and sold them to Wittington as normal. Next time they met, he searched Wittington’s face for any signs that anything was wrong.

“Was everything ok with those mushrooms last time?” he asked.

Wittington shrugged. “I sold ‘em,” he said. “Same as normal. No problem.”

The mouse smiled. This carried on for many more months. But as summer turned to autumn and the leaves started blowing off the trees, reports started reaching the field of some kind of epidemic plaguing the community of mice in fields far and wide. Many said that some mice had eaten so many pies that they had begun to die, and that that soon whole fields of mice would be dead.

The mouse kept himself to himself. He didn’t want to find out anything that would make him feel too guilty. Eventually, he decided that he had to talk to Wittington. The next time they met, he summoned all his courage, and explained that sometimes, just some of the mushrooms in the pies had maybe been poisonous.

“But you put them all in the same pies!” protested Wittington.

“Well,” he said, shuffling his feet, “yes.”

Wittington whistled under his breath and shook his head sadly. “Wow,” he said. “There goes the field mouse community.”

*****

Once upon a time there was an investment banker.

Every morning, before anyone else was awake, he would wake up and scamper into the Big City. There, he would survey the vast array of investments stretched out before him.

He mainly lent money to people so they could buy houses. When he started out, an old banker with gnarled whiskers and a pin-striped suit had taken him aside and said to him:

“Now sonny, if you’re going to go picking people to lend money to, take my advice. You can’t just lend to anyone. Before you lend, you have to make a bit of extra effort, and find out who’s likely to be able to pay you back. If someone has a bad credit history, if they can’t tell you where they’re going to get their money or they used to be bankrupt, they’re less likely to be able to pay you the money back. But if their credit history seem fine, then the loans are safe to make.”

“I have to check every single person who wants a loan?” the banker protested, “but that’s so much extra work!”

“That it is,“ said the old banker. “That it is.”

The banker didn’t want to lend any money to people who wouldn’t be able to pay it back. So, he carefully checked the credit histories of all the people he lent to, and lent to as many people with good credit histories as he could find. He did very well.

But today was different. Because today he had a meeting with an executive from another big investment bank.

“Look,” he said to the executive. “I’ve lent money to lots of people. Now they all owe me money. Do you want to buy one of those loans, so that someone will owe a bit of money to you instead?”

“I don’t deal in loans,” said the executive, wrinkling his nose.

The banker drummed his fingers on the table and tapped at his BlackBerry, thinking. Suddenly, he had a brilliant idea. “I tell you what,” he said, “How how about I mix lots of loans together into one pie, so to speak, and sell the pie to you?”

The executive looked confused.

“That way,” he explained, “You pay me now for the one pie with all the loans in it. Then you can sell the pies on to other banks, and make money for yourself.”

“OK,” agreed the executive. “There’s just one thing. We can’t call it a pie. It sounds completely ridiculous.”

“Oh, the name really makes no difference. We can call it whatever you like. A ‘security,’ perhaps? Or if you don’t like that, how about a ‘special purpose vehicle‘, a ‘special investment vehicle’, or an ’off-balance sheet entity’?”

The executive didn’t see why not. So, rubbing his hands together in anticipation, the banker pooled all the loans together into a security, sold it to the executive, and went to sleep that night a very happy investment banker.

This went on for many months. Soon he was no longer lending any money to people so that he would get it back himself. Rather he was making loans to people, putting all the loans together into securities, and selling all the securities to the executive to sell on to other investment banks.

But one day, looking at all of the work he had to do to check all the credit histories, he had a thought. ‘The funny thing is, now that I don’t get any of the money from the loans back myself, checking every single person before I lend money to them feels like a real hassle. Would it really be so bad if I don’t check them? After all, all the loans look the same when they’re all together in a security – nobody will be able to tell the difference. And besides, once I’ve got the money from selling the securities to other banks, it makes no difference to me if some of them were to people who won’t be able to pay it back…’

And so, he filled the security with a mixture of loans – some loans he had made to people who probably would be able to pay it back, and some to people who probably wouldn’t – and sold them to the executive as normal. Next time they met, he searched the executive’s face for any signs that anything was wrong.

“Was everything ok with those securities last time?” he asked.

“I sold ‘em to other banks,” the executive said. “Same as normal. No problem.”

The banker smiled. This carried on for many more months. But as the third quarter turned into the fourth, and the leaves started blowing off the trees, reports started reaching the bank that some of the people the banker had lent money to couldn’t afford to pay it back. So some of the investment banks which had bought the securities with all the loans in weren’t getting the money they thought they would get. And that was a lot of money. Many said that some of the banks had bought so many, that they had begun to go bust or need bailouts, and that soon millions of people around the world would lose their jobs.

The banker kept a low profile. He didn’t want to find out anything that made him feel too guilty. The next time he met the executive, he summoned all his courage, and explained that sometimes, he hadn’t checked that the person he lent to would be able to pay it back.

“But you put them all in the same securities!” protested the executive.

“Well,” he said, shrugging, “that’s securitisation. Everyone does it.”

The executive whistled under his breath, and shook his head sadly. “Wow,” he said. “There goes the world economy.”
——–

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