Credit Securitization is the banking process resulting from the bundling of both consumer and commercial loans (including mortgages) into packages of securities. According to Bloomberg, securitization is largely a 'shadow banking system' that funds most of the world's credit cards, car purchases, leveraged buyouts (LBO's) and of course, subprime mortgages. Since 2001, the U.S. created and sold more than $27 TRILLION worth of securitized assets. Per the below insightful Bloomberg article, some noteworthy points related to the now virtually non-existant 'Securitization Game' that previously accounted for as much as 20% of the BANKING industry's Total SALES during the past decade :bloomberg.com/apps/news?pid=20601109&sid=a0jln3
* SECURITIZATION pools together loans and is intended to 'slice up' the financial risk of loan default...theoretically making borrowing cheaper for everyone (including the issuers - banks). Unfortunately, when abused by banks, the practice helped create and support a dangerous global 'Debt Culture' that enabled people to live beyond their means via easy access to debt that allowed them to purchase luxury cars and homes they otherwise could not afford.
* Before the invention of securitization, banks loaned money, received payments and profited from the difference between what the borrower paid and the bank's funding cost...During the mid-1980s, mortgage bond traders at Salomon Brothers devised a method of lending without using capital, a technique at the heart of securitization. It works by taking anything that has regular payments - mortgages, car loans, aircraft leases, music royalties - and channeling the money to a TRUST that pays bondholders principal and interest
* As the securitization game caught on, consumer borrowing/bank lending activity dramatically increased. According to the U.S. Federal Reserve, U.S. consumer DEBT tripled in the two decades after 1988 to $2.6 TRILLION !
* Securitization's biggest (and perhaps most FATAL) innovation was 'OFF Balance Sheet Accounting'. If a bank couldn't sell a bond or didn't want to, the asset could be sold to a trust within a so-called 'Special Purpose Entity' (SPE), incorporated offshore in a place such as the Cayman Islands or Dublin. Issuing banks used SPE's to shift securitized assets OFF their books/balance sheets !
* With OFF Balance Sheet Accounting, a bank could originate $100 million in loans, sell off some to investors, transfer the rest to a Special Purpose Entity and not have to hold any capital (to protect against default). The profit could be as much as 1.25 % of the amount loaned, or $1.25 million for every $100 million worth of securitized assets issued...According to a former Chief Financial Officer of Lehman Brothers, Brad Hintz, "The banks could turn a low return on equity business into one that doesn't use ANY equity, which was the motivation for this...It becomes almost like a fee business because it requires no capital.''
* According to industry trade group Securities Industry Financial Markets Association, the U.S. created and sold more than $27 TRILLION worth of securitized assets from 2001...for some perspective, that's nearly twice the U.S.'s 2007 GDP of $13.8 TRILLION !
* According to the European Securitization Forum, securitizations in Europe increased almost SIXFOLD between 2000 and 2007, from 78 Billion euros ($98 Billion) to 453 Billion euros ($570 Billion)
* Because of the subprime-related economic BLOW-UP that began mid 2007, sales of securitized assets have fallen off a cliff...In the U.S., mortgage bonds issued by non-government affiliated entities plummeted to $10.8 Billion in the first half of the year, one-twentieth of the $241 Billion sold in the same period in 2007...Sales of European asset-backed securities, including bonds for car loans and credit cards, fell by 40% to 12.7 Billion euros in 2Q08. European CDO sales fell by 2/3 to 10 Billion euros.
Data Courtesy: Bloomberg
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