Hedge Fund Investors More Rational Than Rash - Economic Letter, August 2007 - FRB Dallas

by Jeffery W. Gunther and Anna Zhang The banking industry’s treatment of loans has undergone a dramatic transformation over the past two decades. While maintaining their traditional role in originating loans and holding them on their books, banks have become more likely to create and sell securities backed by pools of loans and other debt instruments. Banks’ adoption of the “originate-to-distribute” model has been accompanied by equally dramatic changes in risk management. When banks sell these asset-backed securities to institutional investors, they disperse risks outside the banking system. Banks also provide tools to address the risks of loans and asset-backed securities through derivative instruments, such as interest-rate and credit-default swaps. These changes not only enhance banks’ and investors’ ability to manage risk but also increase the availability of credit to businesses and individuals. Insights from the F e d e r a l r e s e r v e B a n k o F d a l l a s EconomicLetter vol. 2, no. 8 aUGUsT 2007­­