The banks’ investment companies had also done so to a great extent. The buyers of the investment companies’ certificates are usually risk averse investors who are choosing between buying short government securities and corporate certificates. When it became clear, or even when there was reason to suspect, that subprime loans were among the investment companies' assets, the demand for certificates fell drastically. Investors instead chose to buy short government securities, which meant that interest rates on these fell. One could say that the investment companies suffered a classic bank run. The parent banks were now forced to fulfil the liquidity guarantees they had made earlier. At the end of July the German bank IKB announced that it had suffered major losses through an investment company that had invested in subprime loans. Some weeks later another German bank, Sachsen Landesbank, experienced similar problems. 1  See also the Committee on the Global Financial System (2006): “Housing Finance in the Global Financial Market”, CGFS papers, No 26. 2  Subprime loans comprised an estimated 13 per cent of the total mortgage stock in the United States in 2006. BIS Review 136/2007  3  The banks then began to hoard liquidity and distrust spread throughout the bank system. Banks that had investment companies did not want to lend money as they might need it themselves to meet their own guarantee obligations. Even banks without investment companies were unwilling to lend money as it was uncertain where in the bank system the credit risk was actually located.
But then they receive everything that is left. The advantage with prioritising the payments in this way is that one can sell the tranches to investors with different risk appetites. Those with a high risk appetite can buy the higher risk tranches, while more cautious investors, such as insurance companies and pension funds, can buy the tranches that are assessed to have the lowest credit risk. But although there are advantages to packaging together securitised loans in a CDO, there are also disadvantages. One disadvantage is that it is expensive, time-consuming and difficult to assess the credit risk in the different tranches. The underlying assets may be of a heterogeneous nature. Moreover, there are products where a CDO is repackaged and in turn included as a component in another CDO, which will of course make it more difficult to gain an overview of the risk content. The credit risk in the structured products is often assessed  BIS Review 136/2007  1  by the credit rating agencies, which also rate the different tranches, at least the more senior ones. The credit rating agencies thus play an important role with regard to the structured products. Pricing is another problem. Tailor-made products are not in general subject to regular trading and price listings are rare. One is often reduced to employing mathematical models, which are based on estimated default frequencies for various credits, given the development previously observed.