The Pros And Cons Of Securitization

The world’s financial system was almost brought down in 2008 by the collapse of Lehman Brothers that was a major international investment bank at that time. The government sponsored these banks’ bailouts that were funded by tax money in order to restore the industry. Before the crisis, banks were lending irresponsible mortgages to subprime borrowers who had poor credit histories. These mortgages were purchased by banks and packaged into low-risk securities known as collateralized debt obligations (CDOs). CDOs were divided into tranches by its default risk. The ratings of those risks were determined by rating agencies such as Moody’s and Standard & Poor’s. However, those agencies were paid by banks and created an environment in which agencies were being generous to ratings since banks were their major clients.

Securitization history can be traced back to 18th century, but the first examples of mortgage-backed securities can be found in 19th century in United States, that are the farm railroad mortgage bonds of the 1860s. After the Great Depression, the government took several initiatives to increase the supply of funds for mortgages loans. Their aim was to support the primary market first, and then the secondary market. In 1934, the Housing Act was enacted and FHA (the Federal Housing Administration) is created by the U.S. federal government. The FHA developed the fixed-rate mortgage, which is an alternative of balloon payment mortgage. In 1938, the federal government also created Fannie Mae, a government-sponsored corporation, in order to create a liquid secondary market of mortgages.

By securitizing the receivables, a larger organization can convert its accounts receivable into cash at once. Hence, individual receivables are combined into a new security and are then sold as an investment instrument. Since securities are backed by a liquid form of collateral, a securitization can result in an extremely low interest rate for the issuing entity. Criterions in ASC 860 states that, transfers in securitization transactions must be evaluated for sale accounting treatment. In addition, they must be evaluated for consolidation by the GAAP criteria, set fourth at ASC 810. Moreover, Securitizations are popular because investors want to acquire collateralized securities and firms with large amounts of receivables have incentives to

Mortgage-backed securities were bonds that were secured by home and other real estate loans. They were created when a number of these loans, usually with similar characteristics, were pooled together. As part of the housing and credit booms, the amount of financial agreements called mortgage-backed securities, which derive their value from mortgage payments and housing prices, greatly increased (Subprime mortgage crisis). Pools of loans were sold to federal government agencies like Ginnie Mae or a government sponsored-enterprise such as Fannie Mae or Freddie Mac. Securitization was the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security. A typical example of securitization

This corporation was created not only to enhance the competition in the secondary mortgage market (Acharya, Richardson et al. 2011), but also to securitize mortgages, as Dodd (2007) mentions. The process of pooling mortgages and selling mortgage-backed securities (MBS) was developed, initially, by Ginnie Mae to reduce debt from the federal budget; the concept of securitization is discussed analytically later. The following years, MBS and securitization assisted GSEs to provide long-term funding in the US secondary mortgage market eliminating liquidity risk from originators while bearing both the credit and the interest rate risk (Dodd, 2007, Wall et al., 2005). The securitization could obliterate the interest rate risk from housing enterprises, as

Private security is growing rapidly throughout several countries. Usually security is militarized to assist with the rise in criminal activity mostly in the urban areas in Trinidad and Tobago. Although the private security continues to answer the call when it comes to forces of globalization and privatization of the challenges of public security and its limited resources (Anyanwu 2012).

Orange County, California filed for bankruptcy in 1994 mostly because of losses experienced in experienced in the Orange County Investment Pool (OCIP). The losses were $1.6 billion in a fund set up to maximize profits through a speculative investment strategy (high yield, interest sensitive and highly leveraged securities) (Saskal, 2005). During a time of low interest rates the investment strategy was returning a great investment; however, when interest rates began the upward rise, the fund began losing money and ultimately was not able to cover loan payments. This led to the county to file for bankruptcy. This paper will discuss some of the ramifications presented to Orange County as a result of their

financial distress costs, capital structure theory argues that increasing debt can increase the value of

If a government wants to help a poor person buy something, it is preferable that they give that poor person a cheque off the bottom line of the budget and not have the banks and financial institutions lend that poor person money in circumstances where he or she can never repay the money. If you securitise something that is a sound product, then the end result of that securitisation will not be as bad as the end result of the securitisation of something that is a dud product in the first place (e.g. sub-prime

Since the onset of the financial crisis 2008, the sovereign debt crisis in western economies and the new financial regulation with Basel III coming up, the financial industry faces the challenge of reinventing itself. The ring-fence for Commercial and Investment Banking, and new economic and regulatory capital requirements will determine the kinds of products banks will be able to distribute. It will have a huge impact in the Investment Banking business, which will suffer tough regulation and supervisory procedures. At the same time, credit risk models will be reviewed because they have failed to predict the crisis of 2008. The current financial and economic crisis doesn’t have any precedent in the past.

Financial transactions are very common in today’s world. In these types of transactions, security must be created. These creations of securities are known as securitization. Security is a financial claim which is exhibited by document. The main feature of securitization is marketability. Henceforth, securitization is creation of marketable and tradable securities which is hinged on the inflows and outflows (cash flows) of the assets and liabilities of an individual. Cash flows refer to those generated in the asset side of the balance sheet mainly receivables; cash in bank and hand, plant and machinery. The Special Purpose Vehicle (SPV) uses these cash flows to issue marketable securities to investors so that funds for the payment to the asset originator can be arranged. Securitization is an innovation in the financial markets. For innovative financing sources, exceeding individual’s cash flow status, acquiring better liquidity position and issuing new securities to new individuals or group of investors, these innovative financing sources have become a necessity. For mortgage financing in secondary markets, securitized instruments are also essential. An asset is eliminated from the balance sheet when it is securitized.

List of abbreviations List of tables Acknowledgements Abstract 1. 2. 3. 4. 5. 6. 7. 8. Introduction Problem statement Objectives and hypothesis of the study Literature review Structure and performance of the financial sector in

The financial services industry is highly competitive and constantly evolving. Not long ago, terms such as collateralized debt obligations, credit default swaps, and synthetic collateralized debt obligations would seem like a strange foreign language. But today, they have risen to become an increasingly larger share of our industry. It’s no secret that these types of financial instruments played a significant role in the financial crisis of 2008-2009. However, they are a necessary evil and must be part of any viable growth strategies in the financial services world. We must take similar risks in order to maximize our profits. That’s

Structured products are blamed for playing important role in the 2007 crisis. The securitisation process changed the way banks operate as the originate-to-hold model replaced by the fee driven originate-to-distribute model. New operating model helped banks reduce maturity mismatch for assets and liabilities. However, such products are not transparent

Organisations and governments across the world have become increasingly dependent on debt over the last few decades. Goods and services are provided on credit and debt is granted to organisations and governments by lenders in different parts of the world. The providers of credit facilities, also known as investors, require a certain level of comfort that the security issuer will be able to repay the debt.