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An interview with Professor Leverage

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The other day I made my way to the offices of the distinguished Financial Architect and Engineer, Professor Leverage (rhymes with arbitrage), to get his insight on recent developments on Wall Street, as well as his vision for the future of his profession. I had last seen him at a garden party that was unpleasantly interrupted by uninvited guests, but by tacit agreement he and I forgot that incident and went directly to the interview:

THA: Professor, all of us were surprised by the sudden downfall of Carlyle Capital ..some observers have postulated that there may have a been a design defect - would you care to comment?

Prof L: Carlyle was designed along very clean, simple, economical lines. The initial emphasis was suggested by the rock firm stability of GSE MBS, undergirding and overarching a spacious courtyard. Using a 20 to 1 ratio, very pleasing to the eye, I suspended a vast dome from a gossamer buttress, extrapolating an imposing and expansive vision of financial possibilities.

Unfortunately, those who executed my conception, when constructing the edifice, neglected certain details that are critically important, omitting reinforcements in critical areas, failing to install appropriate bracing in others. The results were totally unpredictable, unforeseeable, and in no way can they be attributed to design error.

THA: Bear Stearns did not actually collapse, indeed the structure still stands, but the sudden modifications, specifically the large capital buttresses installed by the Federal Reserve and J.P. Morgan, have been cited by some as evidence that the original design and construction was not fully thought out, and that the structure was not in point of fact adequately supported.

Prof L: Bear Stearns was an ongoing project. The original design was evolving along new lines, evoking the untrammeled expansion of financial possibilities, opening up new spaces, creating new vistas, soaring overhead, massive beams...illuminated halls, immense foyers...Indeed, the very ratios used were fluid, dynamic...Who could have foreseen the magnitude of the earthquake that fractured the rock-hard solidity of the underlying RMBS?

THA: Perhaps it would be best to just move along to the future of the profession....

Prof L: (Leaning back, placing the tips of his fingers together, and gazing out the window of his corner office, doing the vision thing) Financial Engineering is one of the oldest professions: admittedly, there is one profession that is older, but we Financial Engineers have been developing our insights for many generations. While change is a given, fundamental precepts remain, ever constant, but always amenable to new permutations. My recent work is suggesting new algorithms that will provide stronger fulcrums, made of unyielding material and fixed in place by unbreakable anchors, as it were. By using these superior methods, ratios of well over 100 to 1 will be possible, and these difficulties we have experienced at 20 or 30 to 1 will be a distant memory, much like the Wright flier at Kitty Hawk when compared to a modern airliner.

THA: Thank you Professor Leverage... (pause) One last question, if I may Sir, certain inquiring minds have expressed concerns about the degree of leverage employed in the twin towers of monoline solidity - Ambac and MBIA. Do you feel that these concerns merit serious consideration?

Prof L: Maybe they are referring to the Capital Ratio as reflected in the quarterly supplements, most recently 120 to 1 for Ambac.

THA: Exactly.

Prof L: The common mind little understands the excellence of the design features incorporated in these structures. To illustrate - an occasional problem observed among inferior constructions has been the risk of collapse due to liquidity crises. However, we have addressed these concerns by avoiding any requirement for the posting of collateral. Absent these constraints, collapse due to liquidity concerns becomes an extremely remote prospect.

To further augment this fortress-like security, we have carefully designed the structures on a pay-as-you-go basis, so that a large part of claims payments can be deferred to a more opportune time, such as 2037, 2039, 2045...

By the time the pig gets through the python we'll all be looking up at the grass.