Securitization Made Insecure

Doug Marshall
Market Assessment
Published July 9, 2008

In assessing America’s current credit crunch and the past year’s near-collapse of markets, an important observation has been made by San Francisco Federal Reserve Bank president, Janet Yellen.

It was the securitization and distribution of bundled mortgage-backed assets that was the “key driver” of our hyper-inflated real estate market, argues Yellen.

Loan originators, says Yellen, with no motivation to do otherwise, bundled and sold loans as mortgage-backed securities to the highest bidder without worrying over-much about their quality, the credit risk they carried, or their liquidity.

In the market that we had, where money was loaned almost without looking, there were several key culprits and factors that contributed to this over-securitization and caused a leveraging of our bank system that, Yellen declares, probably won’t stabilize for at least another year.

• The market’s rapid and insatiable need for mortgage-backed securities left loan originators with no reason or responsibility for properly vetting the bundles that they sold. They weren’t morally aligned or held responsible for the quality of those loans.
  
• Risk management in assessing credit and liquidity was left behind. Institutions and investors, even large ones, who were doing the buying of these bundles relied so heavily on flawed “rankings” of the products that they neglected to carry out their own independent assessments on what they were buying.
  
• Finally, the re-intermediation and deleveraging process, the attempt to come to rely less on debt and more on equity, is probably going to continue for a while until commercial banks, who are less heavily regulated able and therefore able to shoulder this burden, appear healthier.

While Yellen expects the deleveraging process and recovery to continue well into 2009, she can see things getting worse before they get better. Banks must continue to find, and use more wisely, new equity capital. And the balance of losses and growth must continue, especially in larger institutions, to stabilize.

It’s like choosing the treadmill over the buffet. It takes a while to return to your ideal weight, and it comes down to making choices every day that mean a healthier financial institution and venture, and continuing to maintain those wiser decisions as a matter of policy.

Source:
Janet Yellen On Risks And Prospects For The U.S. Economy, Econobrowser, July 7, 2008