Why to blame Nuclear Technology for what happened in Hiroshima? Why to blame CDS & MBS for what happened in USA?

MBS and CDS are “extremely” important innovation in financial industry. It can be compared with space technology which can get us (Humans) to another galaxy.

Now a day’s whenever I come across the discussions regarding current recession, reasonably literate tom, dick and harry would blame MBS and CDS which led to collapse of Lehman and current recession. Even media with its brigade of journalist’s blame MBS and CDS as ‘major reason’ of collapse. Journalist’s quote such “financial instruments” as complex, toxic, zombie and what not.

Indeed those instruments are difficult to understand by common public, but how many of common public and these journalists understand mechanism of financial instrument called “CHEQUE” which they use so frequently.

Finance has evolved from barter system in primitive age to MBS and CDS, the way our transportation has developed from bullock cart to space craft’s.

Finance Evolution:

Barter system- Gold as Currency – Bank – Fiat Money (Paper money) – Exchanges – Insurance Plastic Money– MBS & CDS.

Transportation Evolution:
Animal Cart – Cycle – Scooter – Car – Aircrafts – Space craft’s.

MBS & CDS are the best innovation Finance Industry could have got in last decade. But they got abused by their users. Analogy to that is Nuclear Technology. We can’t blame Nuclear Technology for what happened in Hiroshima or we can’t blame buildings for what happened in earth quake.

All this innovation has own social benefits like nuclear technology would be the main source of power/electricity to human being’s for next 100 years. And Buildings have been providing shelters to humans since 100+ years.

Let me explain you why I believe MBS & CDS are extremely good innovation for Finance Industry and for well being of human society.

First let me explain MBS & CDS in brief.

Mortgage Backed Securities: Banks give loan to businesses and individuals against their property (e.g houses). Now such thousands of mortgages are packaged and sold to some other ‘investor-A’.

Credit Default Swap: It can be compared as insurance against MBS. I.e if any mortgage out of those MBS defaults, Issuer say ‘Insurance firm-A’ of such CDS would pay to ‘Investor-A’. It’s like car insurance, if your car faces an accident Insurance firm pays you the damage.

Why MBS & CDS are important innovation:

1) I believe a manufacturer ‘sole’ purpose should be only ‘production’ , his concentration should be ‘mainly’ on production but unfortunately he has to ‘part off’ his time and effort on arranging ‘indirect’(Plant, Machinery, Building Facility) resource which help in production. i.e manufacturer is ‘obliged’ to use these resources to carry out his ‘core’ function production.

As far as finance ‘perspective’ is concerned these indirect resource (Building & P&M) are ‘dead’ assets on balance sheet if they are not leveraged.

Hence financial Innovation few 100 years back called Mortgages & Loan’s freed manufacturer from such ‘indirect resource obligations’

2) Similarly one of core function of Banks is to lend, but for that they need resource. If buildings, Plant and Machinery (Fixed Block Asset) are ‘Asset’ on balance sheet, so is the ‘Loan/Credit given’ is an ‘Asset’ on balance sheet.

So if businesses can leverage on ‘Fixed Block Asset’, thru financial instrument called ‘Mortgages’. They should be able to leverage ‘Loan/credit given’ as otherwise it would be a ‘dead asset’ on balance sheet and would not ‘help’ in banks core function of ‘lending’.

This freedom was provided by MBS to banks. To leverage/sale their assets (Mortgages)
thru instrument called MBS.

3) Now every Asset has inherent risk attached to it i.e my car and house has ‘risk’ of getting destroyed by fire. So I take an insurance policy.
Similarly assets like MBS have inherent risk of ‘default’. So such risks are mitigated by CDS.

4) Some will argue that leverage ‘kills’ economy, banks like RBS, Citi, etc. Got leveraged by 40-80 times. i.e they would have 1$ in hand and would lend as having 40-80$.

Leverage can be compared with ‘virtualization’ technique used in computer processors. The way Virtualization increases the ‘speed’ of processor, leveraging increases ‘speed’ of ‘economy/business development.’

Hence leveraging to an extent is always beneficial.

Thus MBS & CDS gives ‘opportunity’ to Banks to leverage/use their assets and generate resource to concentrate on their ‘core’ activity of ‘lending’.

But as nuclear technology is regulated under government, as buildings are regulated by municipalities, as stock exchange regulated by regulators. MBS & CDS should also be regulated to prevent the ‘abuse’ of such excellent innovations.