Credit Commentary - Feb. '08

Reinventing Securitization: If It Ain’t Broke, Don’t Fix It. But What if It is Broken
by Andrew Davidson

Securitization has been an important driver of economic growth and efficiency.  Securitization has increased the amount of money available for home ownership and has facilitated the growth of a myriad of economic sectors.  However, in the past year, securitization itself has been the cause of a major disruption in the global economy. 

Securitization is the process by which loan investment is separated from loan origination.  Through this separation, securitization provides the economy with certain benefits.  One clear benefit of securitization is increasing the availability of capital beyond the capacity of the loan originators.  Securitization also offers the benefit of spreading risk and allowing more market participants the ability to impact the pricing of assets.

However, the separation of origination and investment can become counterproductive if the link becomes too attenuated, and excessive risk seeps into the markets.  It may never be possible to ascertain whether sub-prime securitization was the cause of the housing bubble or a symptom of the bubble; however, it is clear that sub-prime securitization will have the impact of exacerbating the fallout from the realignment of housing prices with median incomes levels.

Investors have lost confidence in the securitization process for mortgages.  Even in the prime mortgage market, there has been a significant reduction in securitization volumes.  Perhaps these volumes will return over time with no changes in the securitization process.  However, it may take fundamental changes in securitization to restore investor confidence.  To assess what potential changes might be valuable, it is useful to assess the shortcomings of the current state of securitization.