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

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.

The 2008 financial crisis led to numerous mortgage foreclosure rates (Angelides et al, 2011). Many mortgage companies filed for bankruptcy and this because many of them were running under drastic losses. Financial institutions were unable to lend money because they were operating under losses and this slowed down the economic activities. This unease led central banks to take relevant action to provide funds in order to encourage lending and also to reestablish faith in the commercial paper markets ( United States. Financial Crisis Inquiry Commission , 2010). Not only did the central banks help in relieving the crisis, the federal government was involved in helping the financial institutions by assuming major additional financial commitments. Federal government funded financial institutions dealing with mortgage purchasing and repackaging, Fannie Mae and Freddie Mac were declared bankrupt. Alongside the two government funded institutions that were declared bankrupt, several other main investment banks, insurance companies, and commercial banks tied to the real-estate lending were

With the hunger for yields driving down rates across the fixed income market, an increasing number of articles are coming out warning of lower underwriting standards and the danger in covenant-lite (cov-lite) investments. Covenants on high yield bonds and bank loans are loosening; however we are not observing the excesses of a late-cycle boom. It is easy to point to a few statistics and draw startling conclusions about the below investment grade market. While cov-lite loan issuance is increasing, these securities still provide protection to secured lenders. High Yield bond covenants have also been weakening. Issues are coming to market with investment grade style covenant packages that do not provide strong liens and change of control protections. While loan and bond covenants are getting leaner, credit fundamentals still remain robust.

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

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

From the data discovered based on the increase of technology, it provided an understanding of the traditional process of being granted or providing loans and mortgages. Banks traditionally grant loans to individuals or businesses that meet specific credit requirements and would receive periodic payments. This process continues until the loan is fully paid off. Due to the increase in technology, banks were able to lower their costs for transactions by securitizing loans electronically. This innovation allowed them to bundle up all small loans into a standard debt security, which then could be bought and sold in the financial market. This led to a structured credit product offering that generated large cash flows from a collection of underlying assets with certain risk management. Investors had the opportunity to pick and choose what they wanted to purchase depending on their likes and

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).

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

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

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