Best of the Week
Most Popular
1. Crude Oil and Water: How Climate Change is Threatening our Two Most Precious Commodities - Richard_Mills
2.The Potential $54 Trillion Cost Of The Fed's Planned Interest Rate Increases - Dan_Amerman
3.Best Cash ISA Savings for Rising UK Interest Rates and High Inflation - March 2018 - Nadeem_Walayat
4.Fed Interest Hikes, US Dollar, and Gold - Zeal_LLC
5.What Happens Next after February’s Stock Market Selloff - Troy_Bombardia
6.The 'Beast from the East' UK Extreme Snow Weather - Sheffield Day 2 - N_Walayat
7.Currencies Will Be ‘Flushed Down the Toilet’ Triggering a ‘Mad Rush into Gold’ - MoneyMetals
8.Significant Decline In Stocks On The Cards! -Enda_Glynn
9.Land Rover Discovery Sport Extreme Driving "Beast from the East" Snow Weather Test - N_Walayat
10.SILVER Large Specualtors Net Short Position 15 Year Anniversary - Clive_Maund
Last 7 days
Can Bitcoin Price Rally Continue After Paypal Fake FUD Attack? - 19th Mar 18
2018 Reversal Dates for Gold, Silver and Gold Stocks - 19th Mar 18
This Tech Breakthrough Could Save The Electric Car Market - 19th Mar 18
Stocks Set to Open Lower, Should You Buy? - 19th Mar 18
The Wealth Machine That Rising Interest Rates Create Conflict With The National Debt - 19th Mar 18
Affiliate Marketing Tips and Network Recommendations - 19th Mar 18
Do Stocks Bull Market Tops Need Breadth Divergences? - 19th Mar 18
Doritos Instant £500 Win! Why Super Market Shelves are Empty - 19th Mar 18
Bonds, Inflation & the Market Amigos - 19th Mar 18
US Housing Real Estate Market and Banking Pressures Are Building - 19th Mar 18
Stock Market Bulls Last Stand? - 18th Mar 18
Putin Flip-Flops Like A Drunken Whore On Bitcoin Cryptocurrency Legalization - 18th Mar 18
How to Legally Manipulate Interest Rates - 18th Mar 18
Return of Stock Market Volatility Amidst Political Chaos and Uncertain Economy - 18th Mar 18
Bitcoin Price Trend Forecast, Paypal FUD Fake Cryptocurrency Warning - 17th Mar 18
Strong Earnings Growth is Bullish for Stocks - 17th Mar 18
The War on the Post Office - 17th Mar 18
GDX Gold Mining Stocks Fundamentals - 16th Mar 18
Nationalism, Not the Russians, got Trump Elected - 16th Mar 18
Has Bitcoin Bought It? - 16th Mar 18
Crude Oil Price – Who Wants the Triangle? - 16th Mar 18
PayPal Cease Trading Crypto Currency Bitcoin Warning Email Sophisticated Fake Scam? - 16th Mar 18
EUR/USD – Something Old, Something New and… Something Blue - 16th Mar 18
DasCoin: A 5-Minute Guide to How It Works - 15th Mar 18
Stock Market Downward Pressure Mounting - 15th Mar 18
The Stock Market Trend is Your Friend ’til the Very End - 15th Mar 18
6 Easy Ways to Get What Women Want, for Less! - 15th Mar 18
This Isn’t Your Grandfather’s (1960s) Inflation Scare - 15th Mar 18
Eye Opening Stock Market Index, Volatility, Charts and Predictions - 15th Mar 18
Gold Cup At Cheltenham – Gold Is For Winners, Not For Gamblers - 15th Mar 18
Upcoming Turnaround in Gold - 14th Mar 18
Will the Stock Market Make Another Correction this Year? - 14th Mar 18
4 Ways To Writing An Interesting Education Research Paper - 14th Mar 18
China Toward Sustainable Economic Growth - 14th Mar 18
Stock Market Direction Is No Longer Important - 14th Mar 18
Trade Tariffs Defeat Globalists and Return Prosperity - 14th Mar 18
Stock Market Crash is Underway and Cannot be Stopped! - 14th Mar 18
Are Energy Sector Stocks Bottoming? - 14th Mar 18
Nasdaq Stocks Soars to New Record High After Strong Job Reports - 14th Mar 18
Bitcoin BTCUSD Elliott Wave View Calling for Rally toward $15,000 - 13th Mar 18
Hungary’s Gold Repatriation Adds To Growing Protest Against US Dollar Hegemony - 13th Mar 18
Record Low Volatility in Precious Metals and What it Means - 13th Mar 18
Tips for Writing and Assembling the Classification Essay - 13th Mar 18
Gerald Celente "If Rates go up too High, the Economy goes Down, End of Story" - 13th Mar 18
Stock Market Selloff Showed Gold Can Reduce Portfolio Risk  - 13th Mar 18
Silver Does it Again! Severe Consequences - 12th Mar 18
Has the Stock Market Rally Run Out of Steam? - 12th Mar 18
S&P 500 at 2,800 Again, Stock Market Breakout or Fakeout? - 12th Mar 18
The No.1 Energy Stock To Buy Right Now - 12th Mar 18
What Happens Next When Stock Market Investor Sentiment is Neutral - 12th Mar 18
Economic Pressures To Driving Gold and Silver Prices Higher Long-Term - 12th Mar 18
Labour Sheffield City Councils Secret Plan to Fell 50% of Street Trees Exposed! - 12th Mar 18

Market Oracle FREE Newsletter

Urgent Stock Market Message

The Securitization Boondoggle

Interest-Rates / Credit Crisis 2009 Oct 10, 2009 - 05:56 AM GMT

By: Mike_Whitney


Best Financial Markets Analysis ArticleThe relentless financialization of the economy has resulted in a hybrid-system of credit expansion which depends on pools of loans sliced-and-diced into tranches and sold into the secondary market to yield-seeking investors. The process is called securitization and it lies at the heart of the current financial crisis. Securitization markets have grown exponentially over the last decade as foreign capital has flooded Wall Street due to the ballooning current account deficit.

A significant amount of the money ended up in complex debt-instruments like mortgage-backed securities (MBS) and asset-backed securities (ABS) which provided trillions in funding for consumer and business loans. Securitization imploded after two Bear Stearns hedge funds defaulted in July 2007 and the secondary market collapsed. Now the Federal Reserve and the Treasury are working furiously to restore securitization, a system they feel is crucial to any meaningful recovery.

But is that really a wise decision? After all, if the system failed in a normal market downturn, it's likely to fail in the future, too. Is Fed chair Ben Bernanke ready to risk another financial meltdown just to restore the process? The Fed shouldn't commit any more resources to securitization (over $1 trillion already) until the process is thoroughly examined by a team of experts. Otherwise, it's just good money after bad.

Here's Baseline Scenario's James Kwak digging a bit deeper into the securitization flap:

"The boom in securitization was based on investors’ willingness to believe what investment banks and credit rating agencies said about these securities. Buying a mortgage-backed security is making a loan. Ordinarily you don’t loan money to someone without proving to yourself that he is going to pay you back...

The securitization bubble happened because investors were willing to outsource that decision to other people — banks and credit rating agencies — who had different incentives from them." (Baseline Scenario)

Investors are no longer willing to trust the ratings agencies or rush back into opaque world of structured finance. The reason the securitization boycott continues, is not because of "investor panic" as Fed chair Ben Bernanke likes to say, but because people have made a sensible judgment about the quality of the product itself. It stinks. That said, how will the economy recover if the main engine for credit production is not repaired? That's the problem.

Here's an excerpt from the New York Times article "Paralysis in Debt Markets Deepens Credit Drought":

"The continued disarray in debt-securitization markets, which in recent years were the source of roughly 60 percent of all credit in the United States, is making loans scarce and threatening to slow the economic recovery. Many of these markets are operating only because the government is propping them up.

Enormous swaths of this so-called shadow banking system remain paralyzed. Depending on the type of loan, certain securitization markets have fallen 40 to 100 percent.

A once-thriving private market in securities backed by home mortgages has collapsed, from $744 billion in 2005, at the peak of the housing boom, to $8 billion during the first half of this year.

The market for securities backed by commercial real estate loans is in worse shape. No new securities of this type have been issued in two years." ("Paralysis in Debt Markets Deepens Credit Drought" Jenny Anderson, New York Times)

Securitization could be fixed with rigorous regulation and oversight. Loans would have to be standardized, loan applicants would have to prove that they are creditworthy, and the banks would have to hold a greater percentage of the loan on their books. But financial industry lobbyists are fighting the changes tooth-and-nail. That's because securitization allows the banks to increase profits on miniscule amounts of capital. That's the real story behind the public relations myth of "lowering the cost of capital, disaggregating risk, and making credit available to more people." It's all about money, big money.

Securitization also creates incentives for fraud, because the banks only interest is originating and selling loans, not making sure that borrowers can repay their debt. The goal is quantity not quality. In fact, this process continues today, as the banks continue to originate garbage mortgages through off-balance sheet operations which are underwritten by the FHA. A whole new regime of toxic loans are being cranked out just to maintain the appearance of activity in the housing market. The subprime phenom is ongoing, albeit under a different name.

So why did the banks switch from the tried-and-true method of lending money to creditworthy applicants to become "loan originators"? Isn't there good money to be made in issuing loans and keeping them on the books?

Yes, there is. Lots of money. But not as much money as packaging junk-paper that has no capital-backing and then dumping it on credulous investors. That's where the real money is. Unfortunately, the massive build-up of credit without sufficient capital support generates monstrous bubbles which have dire consequences for the entire economy.

And do we really need securitization? Nobel economist Paul Krugman doesn't think so:

"The banks don’t need to sell securitized debt to make loans — they could start lending out of all those excess reserves they currently hold. Or to put it differently, by the numbers there’s no obvious reason we shouldn’t be seeking a return to traditional banking, with banks making and holding loans, as the way to restart credit markets. Yet the assumption at the Fed seems to be that this isn’t an option — that the only way to go is back to the securitized debt market of the years just before the crisis."

There's only two ways to fix the present system; either regulate the shadow banking system and every financial institution that trades in securitized assets, or ban securitization altogether and return to the traditional model of banking. Regrettably, the Fed is pursuing a third option, which is to pour more money down a rathole trying to rebuild a system that just blew up. It's madness.

By Mike Whitney


Mike is a well respected freelance writer living in Washington state, interested in politics and economics from a libertarian perspective.

Mike Whitney Archive

© 2005-2018 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules