For too long, the idea of “anything goes” on Wall Street was the norm, as investment banks concocted and sold individual and institutional investors exotic baskets of untested and speculative financial instruments like subprime mortgage securities, credit default swaps and collateral debt obligations (CDOs). The products themselves were born out of process known as securitization, and critics say abuses in that market have proven to be a main contributor behind the mortgage market meltdown and the credit crisis that followed.
Securitization is everywhere today. Mortgages are securitized. Car loans are securitized. So are credit cards and student loans. Essentially, securitization occurs anytime an interest-earning pool of assets is packaged together and sold as securities.
Lenders were the first to make securitization mainstream when they decided to “sell” home mortgages to big investment banks, which then converted the mortgages into securities. That was more than four decades ago. During that time, investment banks began to securitize many other kinds of debt and lining up retail and institutional investors, pension funds, and others as their buyers.
For a while, the securitization business thrived beyond all expectations. Demand for mortgage-backed securities was so huge that lenders found they could sell almost any type of security, even the most risky and toxic form of debt.
Whatever the securitization market had in demand, however, it lacked in transparency, disclosures and due diligence. Ultimately, the absence of this much-needed regulation led to financial disaster for investors and the nation as a whole. As reported in a July 6 story by NPR, many critics now contend the housing collapse and the recession itself would never have materialized if the securitization market had been better regulated.
Moving forward, it’s likely there will be a substantial overhaul of the securitization market, including implementing key changes to the manner in which investment banks participate. One proposal is to require securitizers to hold on to a piece of whatever financial product they’re selling to investors. In sharing the risk, they may be a little more careful about what they’re selling, according to the NPR story.