One of the casualties of the global credit crisis has been the notion of "creative finance." It has become all too common, if not obligatory, for analysts to assign blame for the calamity on creative financing or financial engineering. In fact, it has become fashionable to think of creative finance as an aberration of the capital markets in which formerly dull, plodding bankers developed a case of "unintended acceleration." Regulators of every stripe and description are desperately crafting gas-pedal shims for banks to prevent future pileups.
Of course, trying to banish creativity from banking is a fool's errand in a capitalist system. As long as banks exist in the private-enterprise realm they will have an incentive to innovate and find better ways to provide capital and manage risk. Moreover, society is ill served by the crippling of financial innovation.
Securitization, perhaps more than any other capital markets activity, has exemplified creative finance. The initial reaction to the securitization markets' meltdown has proven to be an overreaction. No sooner did the media's fascination with toxic assets lead to articles on arcane structured vehicles than the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp. were all calling for the restoration of the securitization markets. The extraordinary measures taken by the New York Fed, such as the Term Asset-Backed Securities Loan Facility, serve as tacit acknowledgement of the critical importance of these markets to our economy — notwithstanding the fact that they were the venue for abuses that we are still discovering.
In fact, securitization has become a litmus test for how different constituencies view our financial system; those who think our financial markets were dangerously and recklessly unregulated viewed securitization as the accelerant at the inferno; those who think our financial markets created much economic prosperity view securitization as a valuable tool unfairly maligned. Both positions are true. It was the efficiency of the securitization technology that magnified the damage caused by the numerous bad actors. Still, blaming securitization is like blaming the getaway car for the robbery.
As financial institutions face the challenges of the current economy, creativity is essential for our recovery. In particular, the vast capital destruction witnessed over the past three years, compounded by the procyclical demand for incremental capital, would seem to demand new ideas. Absent capital market innovation, banks today can meet increasing capital requirements by either shedding assets or raising capital. Of course, shedding assets when everyone is shedding assets is a prescription for reducing capital not increasing it. Raising capital, which some banks have been accomplishing, is a dilutive exercise at best, that none relish.
Do creative solutions to the capital problems of banks actually exist? We think so. We believe, for example, that there are ways to bridge the "bid-ask spread" which could help unglue the market. (Remember the original Tarp rationale?)
Moreover, there are ways to use derivatives that may help a bank increase its capital without suffering dilution or triggering a change of control. But until we recognize that it wasn't our creativity that caused this calamity, we're unlikely to be receptive to new ideas. There are many human characteristics that played a part in the crisis — greed, arrogance, gullibility and stupidity, just to name a few. Let's stop blaming the human characteristic that can help us get out of this mess: creativity.
