Alignment of interests

I am probably boring about alignment of interests - because I think it is so important. Without it, trading requires a lot of due diligence and you are always unsure if you have missed something. With it, you can have more confidence that your counterparty is not intentionally trying to screw you - the possibility that they are unintentionally screwing you of course remains.

Today the FT points out securitised loans are more likely to default than ones the banks underwrote for their own books:

Defaults on US subprime loans that have been repackaged and sold to non-bank investors have been 20 per cent higher than those kept on the books of lenders in the traditional manner, the study found.

This is completely unsurprising. Psychologically it is very hard to take the same care with something that you know is ending up on someone else's balance sheet as with something that will be yours. Especially if your non-interest income relies on servicing fees. Fixing this isn't hard - simply limit the benefit available from securitisation, requiring banks to keep some of the risk - but it is necessary.