The Insecurity of Asset Securitisation By Robert Boyle



Brief Summary and thoughts on:

Levinson, M. (2014) Economist Guide to Finance, Chapter 5 Securitization


Securitisation is the process in which assets are grouped together and sold at a price which reflects its  value based on long term expected returns. Unlike other government bonds or corporate bonds the stream of revenue comes from the returns on a specific asset. For example if we take the most common asset backed security, the mortgage backed security, revenue comes from the interest payments on mortgages. As a result returns on Asset backed securities are a lot harder to predict as lenders may default on their loans or they may delay payments or they may even pay back the money quicker than expected and all of these unknown variables would affect the revenue which will be received. In return for this uncertainty and therefore risk investors in Asset backed securities get the potential of greater returns than on say government bonds. However many Banks selling the asset back securities will often give guarantees to buyers in order to make them more attractive and governments also sometimes guarantee all or part of the loan payments to encourage house building.
The issuing of Asset backed securities has helped banks to gain capital immediately from the private sector taking away what would otherwise  be an asset on their balance sheet and to free them up to invest in other parts of the economy which may provide better returns.

It is well known that a trigger for the the 2008 financial crash was the subprime mortgage crisis. The danger of the creation and acceleration of mortgage backed securities is that it creates a set of incentives for issuers which encourages irresponsible banking practice. By allowing issuers to out source the risk of mortgages which are issued to private investors they are less inclined to be conservative in assessing the credit worthiness of mortgages which are issued. The Banks can get paid for creating the MBS or ABS and then not take the hit when they default.
This is of course what happened prior to 2008. All this cheap credit caused an asset bubble which eventually burst and because so many different investors, financial institutions, pension funds etc where holding MBS which defaulted it caused an economic recession.
If we take the possibly naive assumption that politicians had some idea of what was happening in he financial world then democratic pressure to promote affordable housing could also be seen as creating a set of incentives which led to policymakers turning a blind eye to these dubious practices. Cheap credit for purchasing homes pleases the public and helps to boost house building by ensuring the demand is present for newly built houses. Any interference which may have caused additional problems in the housing market might have therefore been unattractive.

Whilst asset securitisation seems to be an important part of the modern banking system and helps banks to raise the capital it needs, Careful regulation of these securities is clearly necessary and steps have been taken since the crash to try and ensure it doesn't occur again, such as increasing capital requirements and the creation of banking financial cushions in America so that banks do not rely on taxpayers for bailouts.