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The introductory chapter provides in non-technical language an overview of the history of ratings, the role of rating agencies in financial markets, and the characteristics of the rating industry. It also describes the multiple uses of ratings in markets, especially in regulation and in private contracts, focusing on the unintended consequences that rating triggers might have on issuers. Lastly, the chapter provides a step by step explanation of the process followed by the main agencies to produce a rating: sources of information, quantitative and qualitative elements factored into the credit analysis, interaction with the issuer, role of analysts and rating committees, notification to the issuer, appeals, and publication of ratings. It also explains how agencies perform the surveillance and monitoring of the outstanding ratings. The special features of the process for determining and monitoring structured finance ratings are analysed separately.

This chapter focuses on the boom in everyday borrowing and the qualitative transformations in consumer credit and mortgage networks that have made it possible. This boom is situated in the two principal sets of market networks of Anglo-American everyday borrowing — consumer credit and mortgage networks. It is argued that it is only through qualitative transformations in these networks, which include the forging of close relationships with the capital markets of ‘global finance’, that the boom has been made possible. The chapter also calls attention to the close interconnections that have become consolidated between mortgage and consumer credit networks, on the one hand, and the networks of the capital markets, on the other. It argues that the overlapping and intersecting of previously disconnected and detached networks has materialized through new calculative devices and performances which rationally figure and manage the uncertainties of future repayments by everyday borrowers as ‘default risks’. Particular attention is paid to the default risk management techniques of lenders — especially asset-backed securitization, but also so-called ‘structured finance’ and the use of credit derivatives — that turn on the issue and trading of default risk-related instruments in the capital markets.

While this book was being written, the US economy hovered between recession and recovery, and the global economy remained increasingly polarized and endangered by economic stagnation, instability, and inadequate job and capital formation; in this context, extending the logic of financial innovation to new markets and assets is a significant challenge. This final chapter addresses the application of the logic and practice of high‐yield financial innovations to the future, and in doing so, recounts what has been learned in the book and discusses how the means and methods of high‐yield finance might be applied to future challenges. The first three sections of the chapter are as follows: What have we learned? Yield gaps and the role of the high‐yield market; and Toward global market development. The fourth section, Missing markets, identifies several key issues as emerging global risks to sustainable growth and the capacity of the global economy to finance its future, noting that these are the markets that financial innovations and high‐yield markets, and capital markets in general, must address; they are negative capital flows to developing and transition economies, inadequate demand growth, and the absence of middle‐class development in the developing world, and lack of markets to allocate capital adequately and efficiently for entrepreneurial markets and economic growth. The remaining sections of the chapter are as follows: Capital flows; The importance of financial infrastructure; Emerging domestic markets [EDM]; Structured finance for EDM; Environmental finance; and Intellectual capital securitization.

Based on the importance of CDS, Mehrling argues in his chapter that the current crisis is best seen as the first test of the new system of structured finance. That test has revealed the crucial role played by credit insurance of various kinds, including CDS, for supporting both valuation and liquidity of even the top tranches of structured finance products. The various government interventions of the last year amount, in his view, to the public sector going into the credit insurance business in response to crisis—by either writing credit insurance or taking over insurance contracts written by others. The author calls this the “Paulson‐Bernanke CDS put.” In his view, a basic lesson of the crisis is that the government must be in the credit insurance business in normal times as well.

This chapter presents an overview of the topics and debates discussed in the book. It starts by explaining the definition of social finance, relating it to other, sometimes rival, terms (social investment, impact investing, blended value investing, and so on) and notes the scale of activity and policy interest, and the culturally constructed and contingent nature of what is social in these contexts. The various drivers of these developments are explored, the range of instruments of social finance are outlined, and the emergent market structure in social finance is described. Current issues and debates are then summarized, before presenting brief synopses of the topics discussed in each of the chapters. The introduction concludes by outlining three scenarios for the future of social finance.

This chapter looks into the financial innovation of rating agencies. The agencies were founded following the 1907 crash and matured during the Great Depression in the 1930s. In 2007, discussions of what became known as the global financial crisis revolved around new securities referred to collectively as structured finance. The chapter regards structured finance as a promise to repay the lender or investor. Securitization involved several different institutions buying and selling financial assets from each other, which is supported by probity and creditworthiness. Rating agencies have been viewed on Wall Street as reluctant to anticipate changes in credit quality. The chapter also tackled the concept of repurchase agreements.

This chapter studies calculative risk-assessment practices in credit rating agencies. It identifies two fundamentally different methodological approaches for producing ratings, which in turn shape the respective conceptions of credit risk. The traditional approach sees ‘risk’ as an only partially calculable and predictable set of hazards that should be avoided or minimized. This approach is particularly evident in the production of country credit ratings and gives rise to ordinal rankings of risk. By contrast, structured finance rating practices conceive of ‘risk’ as both fully calculable and controllable; they construct cardinal measures of risk by assuming that ontological uncertainty does not exist and that models can capture all possible events in a probabilistic manner. This assumption—that uncertainty can be turned into measurable risk—is a necessary precondition for structured finance securities and has become an influential imaginary in financial markets.

This chapter examines the economic functions, risks, and regulation of three of the most important dealer-intermediated markets: (i) wholesale funding markets and, specifically, the markets for short-term repurchase (or ‘repo’) agreements and commercial paper; (ii) structured finance (or ‘securitization’) markets in which illiquid loans, mortgages, receivables, and other credit claims are restructured as marketable securities; and (iii) over-the-counter (‘OTC’) derivatives markets and, specifically, swaps. In each case, the chapter examines the role of dealers and other financial intermediaries in making these markets, the risks these markets pose, how these risks manifested themselves during the global financial crisis, and the policy proposals that have been put forward in its wake to address potential market failures.

The chapter analyses the way in which structured finance manages and controls the openness of the future as a source of profit. Financial modelling relies on a specific form of fiction, based on the careful construction of a present image of the future and its uncertainty—expressed by the evaluation of implied volatility. The problem with this approach is that it fails to take account of the reflexive way in which the fictitious future it constructs affects the (not-yet-existing) future reality. This chapter highlights the dual nature of the future as intersection and combination of both the present future and the future present. It concludes that structured-financed models—despite their attempt to control risk by making calculations in the present about the future and about current market expectations of the future—may, in times of turbulence, increase the indeterminacy and unpredictability of future reality.

This chapter examines how financial innovations and excesses in banking contributed to the financial crisis of 2008. It begins by considering the growth of the banking system, with many firms deciding to put spare cash in very short-term loans to investment banks and hedge funds. It then explains why bank capital fell dramatically and proceeds by discussing the ‘shadow’ banking system as well as structured finance and securitization. It also analyzes derivatives and credit default swaps and how the growing interdependence between bank-like activities and financial market-based activities gave rise to bank liquidity problems. Finally, it looks at the nature of incentives and risk-taking as well as the financial institutions' failures in risk management.

This chapter discusses the lessons of the 2008 financial crisis for private-label mortgage-based securities (MBS). It considers both what happened in the general economy and evolution of the mortgage sector from the mid-2000s housing bubble, though the crisis, and into its aftermath. The chapter also highlights the importance of loan underwriting and discusses other key lessons to be learned from the crisis. Mortgage loan origination practices deteriorated markedly in the years leading up to the financial crisis. Underwriting guidelines became increasingly lax. However, a far bigger issue was the failure by many lenders to even follow their guidelines. The deterioration of origination practices helped mortgage loan origination volumes remain high following their cyclical peak in 2003. Structured finance collateralized obligations (SF-CDOs) became major buyers of the subordinate tranches of private-label MBS and influenced how the capital markets mispriced mortgage credit risk, which led to riskier loans.