Financial Lending Notes
December 18, 2009

The Current Role of Securitization

The securitization of loans — high-risk mortgages, in particular — has received much of the blame for the financial meltdown of the past year. But is this blame fair?

In some ways it is, but securitization shouldn’t be ruled out as a viable financial instrument when done responsibly. Still, the demise of securitization, at least for now, has had major implications.

First, borrower access to credit has been severely diminished. It’s estimated that 60 percent to 70 percent of all loans generated between 2005 and 2007 were securitized, and this option no longer exists. Many non-traditional lenders — such as mortgage bankers, captive finance and monoline credit card companies — have disappeared, and the banking industry cannot fill the entire void on its own.

At the same time, credit and underwriting standards have been tightened considerably and the cost of credit has gone up. The implications are obviously far-reaching, affecting homeowners, small and mid-sized businesses, large corporations and everyone in between.

When securitization comes back, which it inevitably will, it likely will not look like it once did. For one thing, the originators of loans will have to keep some “skin in the game.” One of the fundamental flaws of the old securitization model was that originators sold assets without any ongoing responsibility or accountability for the outcome.

In other words, a mortgage banker had no vested interest in whether a home mortgage paid off or defaulted. Proposals currently being debated by Congress and financial regulators would require originators to hold at least a piece of loans that are securitized and not sell off all of the risk. They would also restrict the ability of Wall Street professionals to slice and dice securities as creatively as they once did.