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... Ponzi financing is not just leverage ... its financing that collapse without an ongoing increase in the level of investment, which means, of course, it cannot be sustained in a steady state.

Prudential finance involves debt that can be serviced by the income from the financed activity even if income flows from the funded project fall short of projections ... how prudent is a matter of how bad things can turn and still service the finance.

The trap that CDO are heir too is, rather, a debt-farming shell game. If the top tranche of a CDO is considered an investment grade asset, and so allows participation in non-investment grade activity by those limited to holding investment grade assets, and the low risk premium = high price of the investment grade tranche(s) more than compensate sofr the high risk premium = low price of the junk grade tranche(s) ... then instead of the classical small town bank looking on the interest on mortgages (and small business loans) as its bread and butter, mortgages become a way to generate ongoing commissions on origination, selling the mortgages on in order to be able to originate more.

Of course, market pressure will invariably push the finance sector into non-prudential behavior until a series of events realises the systematic risk that has been lying dormant ... unless a regulatory authority imposes a market penalty for engaging in non-prudential behavior. And it is the reaching for those short term gains (ignoring their attendant long term pains) that has driven the ongoing stripping of prudential regulation from financial systems around the world.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Tue Aug 21st, 2007 at 08:57:16 PM EST
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