Can the financial markets make a comeback?
This first article I found to be an excellent primer on securitization, by an early key participant in the industry, Ethan Penner: http://online.wsj.com/article/SB118817063701609287.html.
In addition to briefly explaining the process, Penner makes a couple of important points about the securitization process, using quotes from the controversial former investment banker Michael Milken.
Benefit: "The democratization of capital" (Milken), namely securitization:
- Allows borrowers better access to the credit markets
- Allows "investors to better target where they want to be on the risk/return spectrum"
Costs:
- Low regulatory oversight - (cited by author as both a benefit and a cost)
- Conflicts of interest - appraiser vs. debt holder vs. ultimate debt owner
- Lax underwriting
- Poorer transparency - like some CDOs, more difficulty pricing the risk associated with a particular debt offering
- Poor liquidity - As I learned the hard way trading the VIX earlier this year, per Milken "liquidity is an illusion" in the sense that trading can instantly dry up when everyone is on the same side of an investment bet
In the second article I'll reference here: The Cost of Complexity (see bottom of article): http://online.wsj.com/article/SB118903970710218805.html my friends at BreakingViews make the argument securitizations are a net cost for the ultimate borrowers. They point out that although mishaps like the S&L crisis are now less likely given the diversification of risk across multiple creditors, the net spread of mortgage rates over T-bills has actually widened for borrowers. I would argue that the comparison might not be so simple, but this is an interesting insight nonetheless.
