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April, No. 249

When banks “warehouse” loans, that is, hold them temporarily before selling them through securitizations, how do they protect themselves against credit risk? This article examines the effectiveness of hedging strategies in the context of the recent heavy losses in financial markets.

Last Updated: 03/12/2008

Hedges in the Warehouse: The Banks Get Trimmed

Adrian D'Silva , Brian Gordon

To Wall Street bankers, market conditions in the spring of 2007 looked close to perfect. The world savings glut meant that liquidity was pouring into the U.S. fixed income markets; interest rates were relatively low compared with historical averages; the U.S. economy was growing strongly; and increasingly complex asset-backed securities (ABSs) that banks had developed as a way to trade loans to other investors were being sold as fast as they could be created.