In the roll call of disappointing earnings and business write downs from investment banks lies a grim common refrain—the once glittering and somewhat mysterious world of structured finance is in trouble. The financial losses and many cuts to staff at banks such as UBS, Citigroup and Merrill Lynch are centered in that new industry, which has led a recent boom in banking profits and a real-world debt bubble.

Structured finance is the esoteric preserve of highly paid people with math PhDs who helped to create a new era in finance, designing a flood of new securities for investors who were hungry for higher returns. The money buying these securities was channeled through a complex, often opaque chain of inter-linked vehicles and funds.

Industry professionals are doing their best to be upbeat about their prospects in public, but increasingly behind the scenes they are preparing for a business drastically smaller than the one that existed before the summer’s turmoil.

When Alistair Darling, the UK chancellor, called for a return to “old fashioned banking”—the kind where banks make loans to people and business and then keep hold of them—in early September, his comments were met with snorts of derision. But now the City of London and New York are facing up to a far greater reliance on old-fashioned ways, forced by the markets to rethink how much debt they can trade away using the little understood ways of financial alchemy.

“The full credit and real economy effects [of this shift] will only be felt in the next six to 18 months,” says Ganesh Rajendra, head of securitization research at Deutsche Bank. “ We think in Europe economists and policymakers are still underestimating these.”

Part of the problem in structured finance stems from investor psychology— their tolerance for complexity has vastly diminished.

When the structured finance sector first started to expand at the start of the decade, it was initially dominated by key players, such as hedge funds, other investors and investment bankers, who had the time to grow their skills and experience with the market and were subject fortunately to few if any disruptions. Thus, while derivatives products tend to be highly complex,

Also In This Issue

Quarterly Review Of Investment Policy
A Flight To Simplicity
The High-Yield Down Investment Strategy
The Dow Jones Industrials Ranked By Yield
Recent Market Statistics