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Securitization survives the fall

September 11, 2009

A year after the government’s seizure of Fannie Mae, Freddie Mac and AIG , not to mention the bankruptcy of Lehman Brothers that sent the global financial system into a tailspin, very little has changed to prevent debt from being sliced and diced, again and again.

This is a mistake. Although there were many factors contributing to the downfall of the global financial system, the repackaging of toxic debt into esoteric financial products was at the heart of the credit crisis when it erupted in 2007.

It’s easy to forget, particularly when many are focused on anniversary tick-tock accounts of the last days of Lehman Brothers, how nasty CDOs — or worse, CDO squareds — became so incredibly popular in the first place.

Yet, after all the damage, the trillions of dollars lost and the biggest state intervention in financial markets since the Depression, there has been no movement to ban their creation.

Securitization in its broadest form — taking underlying collateral, bundling it together and selling it as tradable debt — is still hailed as an important 20th-century invention that has helped worthy borrowers get the credit they need to buy a home, car, or education that would otherwise be out of their reach.

Policymakers, understandably, are anxious to get it started again after the market snapped shut last year. Wall Street, and investors taking advantage of generous financing from the Federal Reserve, are happy enough to oblige.

And it has worked. As of last week, new bonds backed by consumer debt reached $100.5 billion for the year, according to Barclays Capital. While a fraction of the pre-crisis market, that deal volume represents a healthy revival of a near-dead business. Three-quarters of the new deals are eligible for Fed financing.

The problem is phase II — when these securities are then repackaged into something else. At the margins, it’s already under way. Banks are repackaging problematic bonds backed by residential mortgages and the current disaster zone, commercial real estate loans, so they can slice off a new piece that can be resold with better protection.

The amounts are still small, but it’s a reminder of the temptation to shift around a problem asset so investors can feel better about risk.

Although securitization has been around for more than 30 years, the housing and credit boom combined with the computing power of the 21st century gave rise to the proliferation of these repackaged goods filled with bad home loans.

Home loans, though, were just the most bountiful fodder to be found. The next go-around could involve using, say, bonds backed by life insurance policies — the resurfacing fad among Wall Street banks — as the building blocks for a new product.

In the name of simplicity and transparency, the repackaging of securities should just be banned, as I’ve argued before. This will ensure that junky debt doesn’t get cut into so many pieces that understaffed regulators, rating agencies, investors and bank executives lose track of just who is left holding the bag should things head south.

Much of the public outcry and regulatory fervor has been focused on the banks and their reluctance to give up big bonuses for a job well done, or done badly as the case may be.

This is understandable, given the hardship banks and their creations have caused, but this won’t necessarily prevent creative innovation from running amok.

Keeping banks from creating new products out of old ones will go a long way to make sure we’re not right back where we started when the next crisis unfolds.

The Year Since Lehman — related columns:

A year after Lehman, the good news

Banking? Keep it simple, stupid

A year on, it’s still a housing story

Comments

If the Fed really wanted to stop this irresponsible and economically destructive behavior then they must go after and prosecute those responsible for this reckless behavior that crippled this and the global economies. If there is no threat of prison time then there is no deterrent to this abhorrant behavior that is motivated by greed. They know the government will bail them out, brush them off and send them right back out to continue their stupidity unfettered. Proscecute them and let them sit in prison to contemplate the error of their ways. And make them pay for their incarceration too.

Posted by dana | Report as abusive
 

Goes to show us just how rotten and corrupt the “system” has become.

Posted by RFL | Report as abusive
 

THE WORLD OF WASHINGTON AND WALL STREET ARE SO CHAINED AND INTERCONNECTED IN GREEDGATE… WE THE PEOPLE ARE GOING TO HAVE TO TAKE THE ACTION TO PREVENT MEGA—FINANCIAL BANKS AND INSTITUTIONS, FROM CONTINUING THEIR LEGALIZED THEFT. THEY ARE AGAIN TRADING THE ECONOMY INTO VAPOR. THE WORKING PEOPLE ARE LEFT TO FINANACIALLY COMPENSATE THESE ACTIONS. ONE WAY WE CAN TAKE ACTION IS TO PULL OUR DESPOSITS AND SAVING FROM MEGA-BANKS AND GO TO WELL RESEARCHED CONSERVATIVE COMMUNITY BANKS. ALSO LARGER ORGANIZATIONS SUCH AS UNIONS, RETIREMENT ACCOUNTS, THE ASSOCIATION OF CITIES, AND OTHER LARGE ASSOCIATIONS HAVE THE POWER TO REALLY MAKE A DIFFERENCE… THE WORKING PEOPLE HAVE TAKEN THE RAP ABOUT THREE DIFFERENT WAYS FROM THIS LEGALIZED THEFT, AND WE ARE NOW LEFT WITH FEAR AND UNCERTAINTY ABOUT THE NEXT BIG BUBBLE, WHILE THOSE CREATING IT ARE FEEDING AND GREEDING THEMSELVES WITH GOLDEN REWARDS. I AS A CITIZEN HAVE TAKEN THE RAP THREE WAY FROM THE BANKS BEHAVIOR, AND IT HAS PULVERIZED MY LIFE STYLE THAT I CREATED WITH WORK AND DILIGENCE.

I BELIEVE OBAMA WOULD LIKE TO BREAK THIS CHAIN, BUT JUST AS IN HEALTH CARE, POWER HAS BEEN HI-JACKED BY THE VERY GREED CURRENCY OF CORPORATIONS. WAITING FOR WASHING TO BREAK THE CHAIN IS ALLOWING IT TO CONTINUE…

WE THE PEOPLE NEED TO TAKE ACTION..

CLAIRE

 

Two things can be done to keep the MBS/CMBS market somewhat safe. (1) The agencies that rate the securities are going to have to do their due diligence properly and rate the contents of the security properly. This in turn will give the invester a better picture of what they are buying. (2) Local lenders need to stop lending on and Freddie and Fannie need to quit buying loans that do not underwrite. Without question, greed needs to be taken out of the equasion.

Posted by Chuck Rumsey | Report as abusive
 

No more bail-outs, and make them start repaying the monies they recieved. Also, from now on, if a company declairs bankruptcy, theier debtors should be paid at least 80% of each debt, and the balance of company assets be paid to the workers, not the managers/officers.

Also. every CEO/FCO. and highlt placed manager should be barred from ever working again in any like capacity any where in the country/or with a nationally owned evterprise.

Posted by Antoinette Edmonds | Report as abusive
 

I disagree that there are no new obstacles to repackaging and reselling risky loans. The obstacle is that new purchasers of CDOs simply will not do so without actually opening the files and researching thier contents. The last generation of investors were so badly burned – losing 90% or 100% – that these types of securities will not be easily sold.

That is the answer; making up all kinds of politically-motivated grandstanding regulations will have unknown adverse consequences, possibly like the oil embargo of the 70s; there may simply be not enough capital to go around and could result in rationing; people may have to “wait in line” for a mortgage due to knee-jerk revenge legislation.

The banking and financial industry regulators are now on red alert to make sure that institutions value these investments conservatively. That combined with a history of extreme losses in this class of securities is enough.

 

US Congressman: I need $100m to finance my next election and I only managed to raise $1m from my district.

Wall Street investment bank ScrewYou Sucks CEO: Our researchers have found a way to turn your $1m campaign contribution to $50m using sophisticated securitization methods which I assure you can be made completely legal.

Congressman: Excellent. I am pleased to learn that American financial expertise can be retained at home for good use. I will sponsor a bill to enhance the legality of financial securitization.

CEO: It just amaze me how smart our politicians continue to be in times of crisis.

Posted by The Real Deal | Report as abusive
 

For starters, put a label on the thing, same as if it was a bag of potato chips, and pass legislation that whoever ends up exposed to it has to get a copy of the label.

(PS: I do not read SHOUTING.)

Posted by Pete Cann | Report as abusive
 

In a perfect world, the solution suggested in this article could come about. This world is not that.

The solution then is on the people: Eliminate their debt.

One dollar at time, eliminate our debt. It’s possible maintain a consumer society without burying generations to come; it will just require changes.

 

Dear Agnes. If mortgage based CDOs are banned, next day your mortgage rate will shoot up by 2% since most of the financing for mortgages comes from funds who can only invest in investment grade securities. How do you like that?

Posted by Bill | Report as abusive
 

Dana: Prosecute them for what? Securitization is not illegal although it is insanely stupid. And you can’t change the law and then prosecute them for things they did before the law changed.

The best we can hope for is that someone within the government will have the spine to stand up to the banking industry, tell them securitization is stupid and pass a law that makes it illegal going forward.

Posted by Methusselah | Report as abusive
 

There should not be regulations to that effect. Retail and depository banking should be clearly separated from Investment banking. The resulting institutions should be aware that if they gamble and lose, then they will NOT be rescued. Having the depository side of banking as separate entities will mean that client deposits will be safe and failing institutions will only hurt themselves and their shareholders. Perhaps one should add that the persistent shareholder need for ever increasing profit is mostly to blame for institutional risk taking!

 

The USA system is fully corrupt. Its in plain sight for everyone to see. Put these people in jail and throw away the key. Investigate until every last one of them is put away.

Spare me the recovery garbage, spare me the no you cant tell us where OUR money went, just save it for the judge.

This garbage stops NOW!!!!!!!!!!!!!!!!!!!

Posted by Theserf | Report as abusive
 

The banking Oligarchy has a strangle hold on Washington. The banking Industry has received in excess of 800 billion dollars from the Federal Government and perhaps trillions from the Federal Reserve Board. Perhaps an audit would shed considerable light?

In contrast the Federal government has spent only 20 billion dollars of the 800 billion dollar stimulus money to help American citizens in need and revive the economy. There is no consensus on health care for the uninsured and no desire to spend the money to wright this wrong. Unless my math is wrong, this pretty much spells out where Washington’s priorities lie.

Posted by Anubis | Report as abusive
 

Theserf, how can we ever expect thieves to legislate their own activities as illegal?

Posted by Anubis | Report as abusive
 

The secret marriage vow is never spoken
The secret marriage never can be broken

Posted by me | Report as abusive
 

Good points Janus ! (posted 7:01pm GMT)

Posted by Casper | Report as abusive
 

Banks only tightened their noose on credit when people could no longer pay their debt. (When everybody’s making money. Everybody’s happy, as the saying goes). Banks behaving badly is the norm and the house of cards in which this system was built is no longer. But will regulation stop this? And is not regulation a type of disease? I’ve never met a liberal with a tax he didn’t like or a ban he didn’t like. The TARP issue is confusing to a layman like myself but I do know that it never ceases to amaze me on how many economic experts and pundits there seem to be on the other side of the Atlantic. (The writer of this article being one). Big Oil created this mess and the almighty invisible hand is correcting this. Many Europeans do not have a handle on how we over here take cheap energy (petrol) for granted. Working people like myself, stuffing $20 bill (note) after $20 bill in the coffers of Big Oil, not long after, so many had no money for anything else. Prices of all essential goods went up on this fuel increase. Wages did not.

Posted by Drew | Report as abusive
 

Big Business did not sell me out in this country. Big Government did. Fresh out of high school and full of innocence, I eagerly made $10/hr in 1989. Then $10/hr in 1999 and sadly only $10/hr in 2009. Yet my government imported nearly 0.5 million people each year to be absorbed in our small workforce. That’s 10 million people over 20 years to compete with me for scarce jobs. I’m mentioning this because of a previous post about the ‘evils and corruption’ of free market enterprise. Government making bad choices is equally to blame.

Posted by Drew | Report as abusive
 

I forgot to mention I’m from Canada. Sorry for going off on a tangent. Its always convenient when I can take a nice shot at my country. Canadians often brag about the regulatory hurdles in this country. I’ve seen this land go from a rich prosperous nation to a depressing little backwater of the U.S.

Thanks for listening. Cheerio!

Posted by Drew | Report as abusive
 

The solution is 2″ in front of policy makers faces. Restore Glass-Steagall which would separate Broker-Dealer/insurers from banks with international agreements to do likewise. In the “whatever it takes” rhetoric, that and more is what it will take. Additionally, FDIC oversight could focus on banker loans (and quality) vs capital reserves; allow a safe mechanism for common working schmucks to save for their futures and keep up with the invisible inflation without exposure to the risks and opacity of Wall Street as passive investors thus provide banks with the liquidity to invest in their states and communities.

Broker-dealers/insurance and the lot must be transformed with new capital requirements not buried deep in their books where no investor, not part of the very exclusive insiders club, can find them.

Lastly until the risks through ‘innovation’ of those whose egos are only outstripped by audacity, must have PERSONAL skin in the game. Picking winners and losers politically isn’t adequate. Businesses learned to create money out of thin air through financial divisions not part of their primary business…see GM,GE see AIG-a very long list.

Regulators and the revolving door needs to be slammed SHUT as should for those elite Washington Lobbyists, formerly insiders on the Hill, who ensure war chests for re-elections bids are flowing over.

The financial industry at large believed they could function without the population, replace real production by people with their products of alchemy. The wealthy elite are gluttonous and parasitic.

Without rules, you get chaos. Right FASB?

Posted by Nan | Report as abusive
 

Stop blaming financial products. It is like blaming gun for killing somebody.

I just wondering how many people here understand what is structural product or securitization. So people go in general discussion about how Wall Street is bad.

1. There is good intentions behind securitization. Agencies Fannie Mae, Freddie Mac made residential mortgages much more affordable.

2. There are good intentions behind structural products (CMO, CDO etc) as well as insurance (CDS). After all we all have car/home/health insurances.

The real problem is the lack of law. Corporate law shields executives making while keeping shareholders accountable for management mistakes. People bankrupt banks and walk away with bonuses. At least they should go bankrupt. As long as there is no personal responsibility we will see excessive risk taking.

Posted by Sergey | Report as abusive
 

CDS Good?!! Insurance for default debt is good for economy?! Well, if it’s good how bout i open a bank and have insurance for my own default credit card from my own bank?

Posted by logan | Report as abusive
 

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Ashley.

Posted by Ashley | Report as abusive
 

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