Modern corporate finance
The advent of the securitisation market and the high-yield bond market in the 1970s and 1980s changed the face of western capitalism.
Investment bankers grew rich, but the main change was that companies could borrow more freely. This meant they could grow faster, take more risks and hire new people.
Everyone was touched by these innovations. Companies had more choice on financing. In the US in particular, borrowing increasingly came from the public markets rather than the banking sector, a model that exists to this day and has been slowly migrating to Europe.
High-yield – or “junk” – bonds are the debt issued by lower-quality companies with a higher chance of defaulting. Securitisation is the packaging up of debts and other income streams into a single marketable product, notionally spreading risk across the financial sector.
In the boom times before the financial crisis, however, these structured products designed to lubricate the wheels of financing became devices to allow investors to add embarrassing levels of risk to their portfolios. A vast acronym soup of instruments emerged that few truly understood.
It was the collateralised debt obligations backed by subprime mortgages in the US that were the final undoing of a banking system that had lost track of what was happening to structured products and who owned them.
High-yield bonds – popularised by American trader Michael Milken in the 1980s to allow highly leveraged and other less creditworthy companies to borrow – do not emerge spotless either.
The decade culminated in scandal with the collapse of a raft of lower-rated issuers, Milken in jail for securities fraud and the Wall Street investment bank he worked for, Drexel Burnham Lambert, in ruins.
But these rough-and-tumble instruments did expand the realm of what was possible.
Some argue the reason why the US is doing better than Europe today is in part because it has more of these complex structured products, so its companies can borrow more liberally and therefore grow faster.
In Europe, the market in asset-backed securities is largely dead, making companies more reliant for financing on the banks – which are themselves stricken.
Michael Stothard