Background
Securitization is a financial process where several non-marketable assets, such as individual mortgage loans, are bundled together to form marketable securities. This technique transforms illiquid assets into liquid ones, enabling easier trading and lending in financial markets.
Historical Context
Securitization has its roots in the mortgage-backed securities (MBS) market that began in the United States in the 1970s. Initially intended to enhance the availability of mortgage financing, it has since become a critical component of modern financial markets. The monumental increase in securitization transactions was observed in the 1980s and 1990s, where various forms of asset-backed securities emerged.
Definitions and Concepts
Securitization: The process of pooling various non-marketable assets into a single financial instrument that can be sold in the financial market. This helps reduce idiosyncratic risk and brings liquidity to otherwise illiquid assets.
Idiosyncratic Risk: The risk associated with individual assets, such as a single mortgage. This risk can often be mitigated by diversification.
Mortgage-Backed Securities (MBS): An example of a financial instrument created through securitization, where multiple mortgage loans are bundled and sold as a single security.
Major Analytical Frameworks
Classical Economics
Securitization wasn’t a primary focus in classical economic theories, which primarily concentrated on production, value, and distribution within a free market system.
Neoclassical Economics
Neoclassical economists would view securitization as a means to improve market efficiency. By transforming illiquid assets into liquid financial instruments, it enhances the allocation of resources and capital in the financial market.
Keynesian Economics
From a Keynesian perspective, securitization could stimulate economic growth by increasing access to credit, thereby facilitating higher levels of consumer spending and investment.
Marxian Economics
Marxian economists might critique securitization as a process emphasizing financialization over productive investment, potentially contributing to systemic instability.
Institutional Economics
Institutional economists would emphasize the role of legal and financial institutions in shaping the practice of securitization, considering the rules and practices necessary to mitigate associated risks.
Behavioral Economics
Behavioral economists might focus on the incentives and motivations of participants in securitization markets and how misaligned incentives can lead to suboptimal outcomes, such as during the financial crisis of 2007-2008.
Post-Keynesian Economics
Post-Keynesians might critique securitization’s role in increasing speculative financial activities, which could lead to financial fragility and economic instability.
Austrian Economics
Austrian economists would be wary of securitization if it results from regulatory interventions that distort market signals, potentially leading to unsustainable credit expansions.
Development Economics
Development economists might consider the benefits and risks of securitization for emerging markets. Properly managed, it can provide significant capital influx but also exposes markets to global financial instabilities.
Monetarism
Monetarists might appreciate securitization for increasing the breadth and depth of financial markets, aiding the smooth transmission of monetary policy.
Comparative Analysis
Different economic schools have distinct views on the benefits and risks associated with securitization. While it is seen as a tool for enhancing market efficiency, liquidity, and risk distribution, critics highlight the potential for financial instability, systemic risk, and misaligned incentives.
Case Studies
A significant case study illustrating the implications of securitization is the 2007-2008 Financial Crisis, where excessive securitization of subprime mortgage loans significantly contributed to global financial instability. This period highlighted both the potential and perils associated with securitization.
Suggested Books for Further Studies
- “Securitization and Structured Finance Post Credit Crunch: A Best Practice Deal Lifecycle Guide” by Markus Krebsz
- “Asset Securitization: Theory and Practice” by Joseph Hu
- “The Securitization Markets Handbook: Structures and Dynamics of Mortgage- and Asset-backed Securities” by Charles Austin Stone and Anne Zissu
Related Terms with Definitions
- Asset-Backed Security (ABS): A financial security backed by a pool of assets, often including loans other than mortgages.
- Collateralized Debt Obligation (CDO): A complex type of ABS, consisting of various debt instruments that are pooled together to reduce risk.
- Credit Default Swap (CDS): A financial derivative allowing an investor to “swap” or offset credit risk with that of another investor.
