How securitization works

By Felix Salmon
October 15, 2009
John Bird and John Fortune should simply appear directly on Go watch their latest George Parr interview, it's fantastic:

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It seems so obvious: of course John Bird and John Fortune should simply appear directly on Go watch their latest George Parr interview, it’s fantastic:

GP: You can’t have it both ways. Everybody says that banks have got to be boring. Well, you’ve got to have an incentive to be boring.

There’s also a wonderful explanation of how securitzation works, at about 5:30.

GP: We thought we’d found a way where even if house prices didn’t go on rising forever, we wouldn’t have to worry about it.

Q: This is securitization.

GP: Securitization. You see, the problem about lending money who don’t have a glimmer of a chance of paying it back is that there’s a risk.

Q: That they won’t be able to pay it back?

GP: That’s not a risk, that’s a cast-iron certainty. No, no, the risk is that in some very complicated way the bank will lose money. Now what happens with securitization? You see before securitization, we could see the risk. It was there. We had it. And then, after securitization, what that did was, whooooo. The risk was sort of out there. Somewhere. Nobody knew. Then we looked back, and my god, it was still there after all!

Clever, that.


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What he is saying is:

The banks business model is to grown by finding ever greater number of greater fools. The availability of that number is a certainty. The trouble comes when they created products that fool themselves into those greater fools. What’s the words to call those who fooled themselves into the greater fools that they are trying to fool?

The smartest guys in the universe?

Posted by The Real Deal | Report as abusive

I liked:

“But what kind of incentives are we talking about?”

“Well, large sums of government money, that sort of thing “

Posted by matthew | Report as abusive

Fine. Shut down securitization markets. Have fun getting a low interest rate loan of any kind. No bank wants to keep super long term assets sitting on their balance sheet that have low interest rates. What nonsense. Securitization lets capital get around more freely, and can transfer long term assets to investors who want them. It worked for a long time before the meltdown, and it will work for al ong time after.

Investors need to READ THE PROSPECTUSES of securitizations they buy. The risks are right there to be seen. All of the Subprime MBS had detailed stratifications available to ALL who invested in them. It’s not very hard to see from reading them that if housing prices go down that these borrowers won’t be able to refi and will subsequently default. In the end, almost everyone made the assumption that housing prices would go up. This includes Liberal and conservative legislators, financial journalist, Nobel Prize winning economists, Ivy League B-School teachers. This was not a notion that Wall Street could have invented by itself. If you take this out on securitizations, you’ll end up punishing consumers in the end, as much of proposed financial regulation ends up doing.

Posted by Structured Products Guy | Report as abusive

Just perform due diligence like Michael Osinski did with his PA bonds. If your brain can’t handle that, then don’t buy MBS’s.

Posted by Mike | Report as abusive

Potato chips. Think potato chips. Step 1 is to legislate that you don’t have to fight tooth and nail to know what’s in what you’re buying; it’s on the label. I would also suggest that only individuals, by dint of being beneficial owners, be allowed to vote at the annual meeting of any corporation.

Posted by Pete Cann | Report as abusive

Structured Products Guy:

There are securitizations, and then there is Wall Street securitization.

Look around much of the developed world and you see securitized stuffs here and there, but all highly regulated, which includes a healthy dose of ‘self-regulation’, all traded only by pros. Most by done by hedge funds. (Hell, I used to manage a number of Canadian accounts and even they, 1 hr flight from Manhattan, BAN US-style securitization of residential mortgages!)

Look at Wall Street securitization and you find the most notorious con game conjured up by bastards, carefully designed to reap huge profits by turning innocent loans into opium, and selling them as cancer cure. These bastards screw everybody from old pros all the way to little old ladies but escape responsibilities like cowards by using pages of fine prints to game the law.

I hope you can see there is a slight difference between the two.

Posted by The Real Deal | Report as abusive

And what was even better were the non-existent CDS’s written by A.I.G…. Goldman Sachs, Bear Stearns, Lehman, etc., bundle a product, that they knew to be a risky, bogus? investment?? then lured Fitch’s S&P, Moody’s etc., with massive fees into providing an investment??? grade rating assuring them that they had “insurance” policies to cover any “possible” loses…

Let’s see now, Bernie stole a mere $65 billion, and will be in the cross bars hotel for eternity… yet not one of these, how large a campaign contribution check do we need to write crooks, has even had a finger pointed at him/her/it by congress… it would appear that money really can buy happiness… in the scheme of crookery, compared to these geniuses, Bernie is a picker…

Seems to me that congress and the administration are creating czars as fast they can to compensate these bastards…

Posted by Stan Brody | Report as abusive

Structured Products Guy wrote: “No bank wants to keep super long term assets sitting on their balance sheet that have low interest rates.”

Silly me, I thought that was the definition of a bank – you know, borrow short and lend long. Because someone has to do that, and if not the banks, who? Possibly more pertinently, if not the banks, then why have banks?

Posted by Ken | Report as abusive

Why is it that the necessary “incentive” these days always means a payoff?

I think we should start mining the vast array of negative incentives available to us (sticks, vs carrots), such as “if you don’t do X we’ll break up your oligopoly” or “if you don’t do X we’ll throw you in jail”.

Posted by PM | Report as abusive

@ The Real Deal
Are you calling 300k loans to people with 620 credit scores and NINA documentation innocent? I look at the docs for the nastiest most Wall Streetish subprime securitizations. The collateral is crappier than the structure. If you read the structure carefully, a first year analyst fresh out of school can point out that if home prices fall, borrowers won’t be able to refi, won’t be able to afford the mortgages, and defaults will be rampant. The structure is not that opaque. Sure it could be simplified, and in the future it probably will, but don’t blame the structure when underneath it was greed from EVERYONE. Borrowers, originators, brokers, and investors.

Posted by Structured Products Guy | Report as abusive

‘splain me Lucy why Andrew “I’m running to be Guv and going after everyone” Cuomo hasn’t gone after even one person at A.I.G… what would a fire insurance policy written without the ability to pay off for a covered event be called… fraud… why then, isn’t anyone being prosecuted for the fraud committed by A.I.G in writing the CDS’s??? Without which, none of this could have happened… people DID read the prospectus’… did see the pitfalls… but were sold a bill of goods by the brokerages and underwriters, providing a “wonderful” guaranty against any loses…

Must be the size of the campaign contribution check written against “our” TARP funds…

Posted by Stan Brody | Report as abusive

Structured Products Guy:

Of course we cannot call those NINJ subprime loans innocent. They are perpetrated by a different gang of bastards in the field.

If you ask me to agree that there are things worse than securitization in the whole mess, yes I agree. The subprime stuff is the original sin. Securitization aggregates and multiplies that. There is nothing fundamentally wrong with securitization. It is how it was done by WSM gang – using CDO slice and dice, using fraudulent ratings, using CDS trading to cover up the risks and leverage up the profits. I maintain that the combined practice is criminal, prospectus fine prints notwithstanding. Yet no one has been charged. Could this be the perfect crime of the past 4 centuries?

Posted by The Real Deal | Report as abusive