Introduction to Securitization

CHAPTER 14

Benefits of Securitization to Financial Markets and Economies

In this last part of the book, we will look at securitization’s economic impact. At the time of this writing, there are questions about the contribution of securitization to financial markets and to an economy because of the now well-documented problems of the securitization of one asset class: subprime mortgages. The disastrous economic consequences of this sector of the securitization market started out as a credit risk concern regarding subprime mortgage borrowers in July 2007, spread to credit concerns in other lending markets, and by fall 2007 raised issues regarding liquidity. By late 2007, there were concerns about the impact of the subprime mortgage crisis on the global economy.

The root of this crisis was the lax underwriting standards used by aggressive mortgage originators. There are at least three developments that might have lead to the lax underwriting standards. First, housing prices had been rising since the early 1970s, increasing borrowers’ equity in mortgaged houses and resulting in lower default rates. Second, the Federal Reserve brought down interest rates to historically low levels in the 2001-2002 period, thereby providing the right economic environment to not only approve loans but in the creation of mortgage designs that make it easier for subprime borrowers to qualify for loans such as fixed-rated interest-only mortgages, pay option adjustable-rate mortgages,⁶³ and stated income ...