What Is Securitization?
Securitization is the process of pooling financial assets or debt instruments into an entity in which shares can be bought and sold by investors. These shares are securities that allow individuals and institutions to invest in the underlying financial assets much like an investor can purchase stock in a company, except the underlying assets are financial instruments such as loans.
What Are The Benefits of Securitization?
Securitization Offers Greater Access To Investors
Securitization allows investors to invest capital in a financial asset or debt instrument in proportion to the size of the security, not the size of the underlying financial instrument or pool of financial instruments.
This means an investor does not have to buy an entire mortgage to invest in a mortgage, nor does an investor have to buy an entire pool of mortgages to invest in the benefits of grouping many loans together. The investor can invest in relation to a minimum amount or value of the security with respect to the amount they are looking to invest.
Securitization Provides Greater Liquidity And Funding For Credit Markets
Securitization has led to a market where the security, not the underlying financial instrument can be traded. This facilitates trade and investment for investors and serves as a mechanism to draw investment capital to fund the underlying financial instruments.
As an example, securitization played a role in the recovery of commercial real estate markets after the savings and loan crisis in the 1980s and 1990's. After the savings and loan institutions failed, the securitization of commercial mortgages provided needed liquidity to commercial real estate markets.
What Are The Drawbacks of Securitization?
Investors may not be aware of all of the details of the underlying financial assets or how they where pooled. The ease and distance of trading securities relative to the origination, management, and pooling of the underlying financial instruments can mean investors are not fully aware of all of the risks involved.
The 2008 financial crisis is an example of this type of risk where low quality mortgages were pooled into mortgage backed securities that where acquired by large institutional investors. The investors were unaware of the magnitude of mortgages that were issued to high risk borrowers that resulted in a high rate of default. The result was a collapse in the value of the financial assets held by these institutions and the economic crises that ensued.