The Future of Securitization

Abstract:     
This essay examines the future viability of securitization in light of its causal involvement in the subprime-mortgage financial crisis. Securitization has many positive attributes. It efficiently allocates risk with capital, it enables companies to access capital markets directly (in most cases at lower cost than the cost of issuing direct debt), and it avoids middleman inefficiencies. When the securitized assets are loans, securitization helps to transform the loans into cash from which banks and other lenders can make new loans. These positives might be outweighed, however, by four negatives of securitization revealed by the subprime crisis: subprime mortgages were a flawed asset type that should not have been securitized; the originate-and-distribute model of securitization can create moral hazard; securitization can create servicing conflicts; and securitization can foster overreliance on mathematical models. This essay examines these negatives and the extent to which they can be remedied in the future.

Working Paper Series