Evolution of securitization, Financial Management

Securitization is a financial innovation born out of the necessity the savings and loan associations of the United States of America face to save themselves from impending bankruptcy. When inflation began to rise and the market interest rates rose in step with it in the 1970s, these thrift (savings) institutions found that their spreads were turning negative, since they had to pay high market rates to attract short-term deposits (to compete with money market mutual funds and commercial banks offering money market accounts) and these rates were higher than the rates they were earning on the long-term mortgage loans which had been sanctioned years before. While mismatched assets and liabilities became a primary problem for the thrift institutions, another problem was excess demand for loans compared to the deposits collected by S&Ls, banks, etc. The solution to these problems was found in securitization of debt.

The securitization of residential real estate began in the United States on the basis of the deeply ingrained principle that the American family needs a home and will maintain that home over most other possessions; hence, the concept of using mortgage loans to support investment-grade securities. Here, the process of securitization took roots. Statistical research also showed that the default rates on residential real estate loan were both minimal and predictable. Investment bankers saw this as an opportunity to generate liquidity. By 'packaging' hundreds of individual real estate mortgages into one large security, great confidence could be achieved in terms of the financial characteristics of the group. While it would be impossible to guess the probability and timing of the default of any individual mortgage, one could frame reliable predictions regarding average default for a group of mortgages on the basis of historical studies of other similar large pools of mortgage loans.

Posted Date: 9/8/2012 7:49:45 AM | Location : United States

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