It was impossible to gain a clear insight into the complicated CDO structures. Consequently the interest rates on the interbank markets soared. Parallel to this, scepticism towards the credit rating agencies' ability to grade structured products increased, and this concerned not only products containing subprime loans. Several central banks decided at this point to intervene in different ways in the interbank market. In general, the interventions contributed to reducing interbank rates towards desirable levels for shorter durations. For the longer durations the difference between the interbank rate and the risk-free rate remained substantial. The unwillingness to lend money was a hard blow to institutions dependent on financing from the market. For example, the British mortgage lender Northern Rock was forced to seek help from the Bank of England to manage its acute liquidity problems when it could no longer obtain financing. The market turbulence during the autumn had relatively limited effects on the Swedish banks. The main effects were higher financing costs, some changes in the value of bond portfolios and less activity on some markets. Here an important factor was the fact that the Swedish banks did not have any significant exposure to securitised subprime loans, neither directly nor indirectly through investment companies. Deficiencies in the functioning of the credit markets have been exposed The rapid developments in the financial system over the past decade have essentially been beneficial. There is no reason to wish we were back in the financial iron age of the 1980s.
Illiquid loans are converted into liquid bonds, which can easily be sold. Many investors are happy to have credit risk in their portfolios for better diversification. But they do not want to manage individual credits, and they also want liquidity in their investments. They therefore appreciate the securitised products. In recent years, however, it has become increasingly common for securitised loans (which have been converted into bonds) to be repackaged into various so-called structured credit instruments. An impressive variety of this type of structured product has arisen in a short period of time. Perhaps the most common form are those known as CDOs, Collateralised Debt Obligations. With a CDO it is possible to put together bonds from many different securitised loan portfolios and even to add other assets if desired. The idea is that the portfolio that has been put together is structured in different parts (tranches) with different credit risks (this is in practice often done by the large international investment banks). When interest income from the underlying assets starts coming in, it is distributed according to the order of priority of the tranches, or their seniority. First, the most senior tranches receive their allocation. After that the income is distributed to the second most senior tranches, and so on. Investing in a junior tranche thus entails greater risk than investing in a senior tranche, but on the other hand the earnings are higher. At the bottom is an equity-like part, which is only paid when all the others have received their share.