Introduction to Securitization

KEY POINTS OF THE CHAPTER

• Securitization has an impact on a country’s financial markets and economy.

• While questions about the contribution of securitization have been tainted by the subprime mortgage crisis that is clearly attributable to lax underwriting standards, securitization remains an important process for corporations, municipalities, and government entities seeking funding.

• With respect to reducing funding costs, the same theoretical issues about the relevance of a firm’s capital structure that were first addressed by Modigliani and Miller are being asked in securitizations.

• Asset securitization has the potential for reducing funding costs by breaking up a company into a set of various financial assets or cash flow streams with some of those various subsets of financial assets being isolated from the general creditors of the originator and benefit only the investors in the asset-backed securities issued.

• The question in a securitization is if the benefits accruing to the holders of the asset-backed securities come at the expense of the firm’s other creditors.

• There are two arguments proffered as to why this is not the case: structural arbitrage argument and increased financial leverage argument.

• The principle of structural arbitrage asserts that there is an arbitrage in risk-reward tranching of the cash flows for different market participants and, as a result, the sum of the parts is different from the whole.

• It is argued that greater financial leverage ...