High finance has never been more sophisticated. Bankers have never been more clever. Yet in the US subprime lending boom, banks fell over themselves to advance 100 per cent loan-to-value mortgages to out-of-pocket deadbeats. According to industry folklore, even an insolvent arsonist was given accommodation.
Lending standards to private equity are collapsing just as risks rise and returns are being competed away. "Cov-lite" loans are the order of the day, meaning that restrictions on a borrower's interest cover and balance sheet leverage cease to apply. This has prompted Anthony Bolton, Britain's most admired fund manager, to warn of impending doom. So what is the explanation for such apparently aberrant behaviour? At one level, it is simply that banks no longer have to worry about loan quality in securitised markets where the loans they originate are immediately sold. So the more pertinent question is, why do investors buy from the banks? The answer, as Henry Maxey of the Ruffer fund management group argues in a forthcoming paper for the Centre for the Study of Financial Innovation, is that Wall Street has solved their most pressing problems with its invention of structured products. Take the hedge funds, in which conventional investors such as pension funds invest increasingly via hedge fund of funds. These intermediaries typically aim for positive returns of 1 per cent a month, net of fees, with low volatility. If the hedge funds they back fail to deliver on 3- to 6-month performance figures, they are culled.