Introduction to Securitization

BENEFITS OF SECURITIZATION IN AN ECONOMY

Securitization is as necessary to any economy as organized financial markets. The end result of a properly structured securitization is the creation of tradable securities with better liquidity for financial claims that would otherwise have remained bilateral deals and been highly illiquid. For example, very few individuals would be willing to invest in residential mortgage loans, corporate loans, or automobile loans. Yet they would be willing to invest in a security backed by these loan types. By making financial assets tradable in this way, securitization (1) reduces agency costs thereby making financial markets more efficient and (2) improves liquidity for the underlying financial claims thereby reducing liquidity risk in the financial system.

A number of researchers have found that the securitization of residential mortgages has lowered rates paid by borrowers. See, for example, Hendershott and Shilling (1989), Sirmans and Benjamin (1990), and Jameson, Dewan, and Sirmans (1992). Lucas, Goodman, and Fabozzi (2007) have reported that the securitization of commercial and industrial loans for collateralized loans obligations has helped not only fuel the growth of the institutional loan market but has diminished the role of banks as holders.

The Case of the U.S. Housing Finance Market

To appreciate this important contribution to an economy, consider the origins of securitization.⁶⁶ In the first decades of the post-World War II period, ...