Comments on: Be happy about the lack of securitization A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: Sandrew Fri, 09 Oct 2009 18:54:25 +0000 Yes, David. I overreached with “never”. I also neglected to finish before posting my comment. I’ll try again.

My skepticism is driven by the view that the securitization market (or at least large parts of it) ceased to function properly some time early this decade. The grand idea, as I take it, was that securitization was supposed to bring liquidity to various classes of illiquid assets like mortgages et al by the following mechanisms: (a) aggregating (and in many cases tranching or otherwise reorganizing) risks, (b) centralizing the analysis those risks at credit rating agencies, and (c) transferring those reorganized risks and rewards to those better suited (than originators) to bear them.

I think what we came to terms with in 2008 was that there had been problems in that chain of logic all along. By aggregating and tranching risks, originators discovered new-found demand for what would have previously been considered imprudent loans. By centralizing risk analysis in the hands of the ratings agencies, investors grew complacent in their own due diligence. And the hope that securitized products would end up on the balance sheets most tolerant of the risks turned out to be spectacularly flawed. The demand was ravenous for the seventy-some-odd percent of the securitized structures granted AAA ratings. Whether this demand was due to investor appetites for low risk or merely for the appearance of low risk (and for the lower capital charges that come with that appearance) remains to be demonstrated.

By: David Sucher Thu, 08 Oct 2009 20:05:11 +0000 Sandrew.
Why do you state that the securitization market never worked well?
So far as I understand, it worked quite well between 1980 – 2002 for single-family home loans..
And farther back of course for FHA and VA loans which I believe were also packaged but because the initial underwriting was strict, had very low default rates.

It seems to me that the securitization market didn’t work well when it was not well-managed and well-regulated and that sums it up.

By: Sandrew Thu, 08 Oct 2009 19:41:17 +0000 Point taken, William. But I think some of the skepticism toward securitization on the part of Felix, myself, and many others is driven by the view that the securitization market never functioned properly in the first place. The grand idea, as I take it, was that securitization was supposed to bring liquidity to various classes of illiquid assets like mortgages et al by the following mechanisms: aggregating risks, centralizing the analysis t.

What say you to these concerns?

By: william Thu, 08 Oct 2009 10:19:20 +0000 In my opinion, not restarting the securitisation market can only be a very bad thing. I admit that it’s good that predatory sub-prime mortgage lending, to people who could not afford to pay their mortgage loan, has now stopped. But does that mean the whole market should close down?

Do you think it a good thing that financing for small to medium sized businesses, commercial properties and consumer loans should also be shut down or severely restricted? Do you think it is a good thing that mortgage loans will cost perhaps three times as much as they used to for pristine borrowers?

Personally I think not – you and I will suffer along with everyone else. I am the first to admit that things went to far at the peak of the market and it needed to be reined in.

Check and balances are required to prevent another mess like this from re-developing. But, at the same time, it is also clear that, unless the primary securitisation market is restarted (and by that I mean bank issuers selling securitised debt to real investors) then we are in for a very long, drawn out and nasty recession which will bring out the worst in our society.

Economists reckon that unemployment will plateau next year. Personally I don’t think it will unless vital financing gets through – and that means the securitisation market needs to restart.

To put it in context, since the crisis began, banks have been unable to sell their securitised debt and (in Europe) there is around €1.3trln of securitised debt that is now sitting on bank balance sheets which is eligible for repo funding with the European Central Bank.

If this debt was pushed to the ECB in one go (unlikely, but not impossible) the whole financial system would go into meltdown. You think I am being a bit melodramatic but the fact of the matter is that the ECB does not have the balance sheet to provide that sort of financing. It’s a bit like a hundred people trying to hold onto a rubber ring.

So, I beg to differ, we really do need to get this market back on its feet, if only because its too big and the consequences too damaging – to ignore.

We need more people to write about this market with more understanding.

By: KenG Thu, 08 Oct 2009 01:44:36 +0000 I thought people just invested in fannie mae and freddie mac, I didn’t realize they actually bought collections of specific grade loans from them (sub-prime, different tranches, etc.)? did they sell bonds in specific collections of mortgages? If they did that, then they wouldn’t have lost so much money, as the people who bought the CDOs were the ones who lost $$ (unless you then bought CDSs that the government was willing to cover).

By: David Sucher Wed, 07 Oct 2009 23:12:38 +0000 KenG.

Perhaps I am mistaken but I am pretty sure that the secondary market for loans does (or did, anyway) always bundle loans together. In fact I don’t think you could ever go out and buy ONE loan from Fannie Mae or Freddie Mac.

You can buy individual DOT or Real Estate Contracts but that owner-carried paper makes a whole different market and I doubt (since they have no PMI or conform to any particular standards) you could rate a package of them.

By: KenG Wed, 07 Oct 2009 21:26:59 +0000 @David, securitization is not the same as a secondary market for loans. There’s nothing wrong with re-selling loans, but securitization packages up a whole bunch of them into one package, so the buyer doesn’t really know what they are getting, unlike when investors buy individual loans. It’s kind of like buying ground hamburger meat, you have no idea what it was originally like, nor do you know if there was e coli in any of the meat before it was added to the mix. If you just bought a chunk of meat, it could be tested for it, but not the ground up stuff. For that, like the loans that are combined into a giant package of loans, you have to depend on a third party rating organization – and that’s where things break down.

People have died from eating meat contaminated with e coli, because the buyers of ground up meat (which comes from many different sources) had no way to grade all of the components of the ground meat. Similarly, businesses have failed because they bought ground up loans when they had no way to grade all the components of the bonds.

By: the Shah Wed, 07 Oct 2009 20:36:49 +0000 It’s scary that Krugman won a Noble Prize, the guy is a bit of a nutter these days. He can’t let go of his ideas because (I think) he has some superiority issues. His bottom line message is scary: let’s spend our way out of this mess and doing via the USG. YIKES! I’m not saying government is any better or worse than the XYZ mega-corp but corporations can come and go, the government stays forever. Sorry if I’m a little off-topic, but I since this article is essentially a defense of Krugman, it’s important to weigh his words… like if Rush Limbaugh starts attacking someone for being addicted to drugs, or overweight, or a loud-mouth, etc.

By: Murray Wed, 07 Oct 2009 20:31:37 +0000 Urgh, Felix, your continued insistence on treating the securitization market as if it were a living, thinking being is just dumb. It’s a financing tool, one that got abused just like others have in the past. It’s equally asinine to believe that direct lending from banks to whomsoever automatically means credit decisions are smarter.

Based on your approach, we should have let the stock market die in 2000 because of the dot com bust and should have banned bank lending after god knows how many poor lending decisions they have made over the years – including in this crisis. Wachovia’s and WaMu’s option ARMs, for example? HSBC’s subprime lending losses? Hundreds, if not thousands, of banks’ poor commercial real estate loans?

That’s what happens in a bubble, Felix – people lose their capacity and even their desire to analyse risk properly. Securitization of subprime mortgages is where is showed up most obviously in this crisis. But it was pretty rampant across all products.

By: michaelc Wed, 07 Oct 2009 18:48:25 +0000 To the extent the shadow banking existed to enable regulatory arbitrage, eliminating the regulatory arbitrage eliminates the demand for SIV paper and banks reduce securitizations and lend directly and prudently instead.

But non regulatory arb demand for truly high quality bonds still exists and securitizations should exist to meet that demand.

Without a secondary market, loan risk is even more concentrated in the banks. Is this really a desirable policy goal

I think the Feds objective is to revive a legitimate securitization market so that it can drain those excess reserves as lenders step forward from outside the banking system.

I don’t think anyone thinks, in its current state, the secondary markets is a far supeior system, but it has its useful place. Krugman’s argument is facile and the cnclusion you’ve drawn from it overly simplistic