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Mortgage Securitization--repacking shit


A good explanation of MORTGAGE SECURITIZATION and why scrutiny through owning the debt builds sound loan policies, and selling them thus fails.  What Stewart misses is that when you flood the market with funds, means of distributing them will be created.  Fractional financing by the Federal Reserve created the need to flip loans and the funds for those to buy these packages--jk. 

Huffington Post, 3/28/09 by Hale Stewart,

Krugman is Wrong

Paul Krugman is a Nobel prize winning economist and one of the leading thinkers in the Democratic Party. He is held in high regard by many people -- myself included. In fact, I have cited his work on several occasions and used his statements on television to refute several right wing talking points. However, in one of his latest columns Dr. Krugman advances a viewpoint which I disagree with because it is incorrect.

From the NY Times:

After 1980, of course, a very different financial system emerged. In the deregulation-minded Reagan era, old-fashioned banking was increasingly replaced by wheeling and dealing on a grand scale. The new system was much bigger than the old regime: On the eve of the current crisis, finance and insurance accounted for 8 percent of G.D.P., more than twice their share in the 1960s. By early last year, the Dow contained five financial companies -- giants like A.I.G., Citigroup and Bank of America.

And finance became anything but boring. It attracted many of our sharpest minds and made a select few immensely rich.

Underlying the glamorous new world of finance was the process of securitization. Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans -- all went into the financial system's juicer. Out the other end, supposedly, came sweet-tasting AAA investments. And financial wizards were lavishly rewarded for overseeing the process.

But the wizards were frauds, whether they knew it or not, and their magic turned out to be no more than a collection of cheap stage tricks. Above all, the key promise of securitization -- that it would make the financial system more robust by spreading risk more widely -- turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.

Sooner or later, things were bound to go wrong, and eventually they did. Bear Stearns failed; Lehman failed; but most of all, securitization failed.


But the underlying vision remains that of a financial system more or less the same as it was two years ago, albeit somewhat tamed by new rules.

As you can guess, I don't share that vision. I don't think this is just a financial panic; I believe that it represents the failure of a whole model of banking, of an overgrown financial sector that did more harm than good. I don't think the Obama administration can bring securitization back to life, and I don't believe it should try.

Dr. Krugman's criticism of the financial sector boils down to the introduction of "securitization" into the financial world. His argument concludes:

As you can guess, I don't share that vision. I don't think this is just a financial panic; I believe that it represents the failure of a whole model of banking, of an overgrown financial sector that did more harm than good. I don't think the Obama administration can bring securitization back to life, and I don't believe it should try.

Let's begin with a definition of securitization:

Securitization is a structured finance process that involves pooling and repackaging of cash-flow-producing financial assets into securities, which are then sold to investors. The term "securitization" is derived from the fact that the form of financial instruments used to obtain funds from the investors are securities. As a portfolio risk backed by amortizing cash flows - and unlike general corporate debt - the credit quality of securitized debt is non-stationary due to changes in volatility that are time- and structure-dependent. If the transaction is properly structured and the pool performs as expected, the credit risk of all tranches of structured debt improves; if improperly structured, the affected tranches will experience dramatic credit deterioration and loss.[1] All assets can be securitized so long as they are associated with cash flow. Hence, the securities which are the outcome of securitization processes are termed asset-backed securities (ABS). From this perspective, securitization could also be defined as a financial process leading to an issue of an ABS.

Let's put this into English by using a mortgage as an example. Your mortgage is a "cash flow product[ing] financial asset." What that means is when you take out your loan you must provide the lender with a predictable set of payments -- namely, your monthly loan payments. These payments are based on the length of time the loan will be outstanding, the borrowers overall credit risk, the amount of money borrowed etc..... The point is the lender will be receiving a predictable amount of money on a regular basis for a specific amount of time.

Securitization takes your loan and combines it with loans that have similar qualities. For example, your loan is not the only loan where the borrower takes out a 30 year, 5% loan of $100,000; thousands of these loans are written every day. Securtization takes these loans and combines them into one big loan. Then it either sells that big loan as a whole or in pieces or cuts the pool of mortgages into different bonds which it sells to different investors. The former security is called a pass-through while the latter is called a collateralized mortgage obligation, or CMO.

The central complaint against the process of securitization is it removes the oversight function from the lender. For example, it use to be that a bank held a loan for the entire life of the loan. As a result, the bank had a strong incentive to perform a large amount of due diligence to make sure the borrower would repay the loan. Compare that to a "lend to securitize" model where lenders make loans they never intend to hold as a long-term asset, thereby removing the incentive to actually perform an analysis of the borrower. Combine that with a ratings "system" that is at best incompetent, investment bankers providing pressure on loan originators for more and more product, a regulatory oversight system which is non-existent and incredibly cheap money and you get a disaster waiting to happen.

Yet securitization provides two incredible advantages. First, it adds liquidity to the financial sector. Instead of having to hold a mortgage until it was paid off, a bank could sell it for cash and then use that cash to make another loan. This allows banks to increase the number of loans it can underwrite, thereby freeing up credit. Secondly, it allows individual investors to target needs and purchase products for those needs. For example, suppose an insurance company anticipated a financial payout in 3-5 years. Securitization allows investment banks to carve pools into specifically targeted assets which will fill the insurance company's need. This allows them to manage their portfolio far more effectively. In short, securitization increases overall credit and provides more tools for financial managment -- both of which increase overall economic growth when property structured.

In correlation, the process of securitization has been around for almost 30 years, yet this is the first time it has been so prominently in the spotlight. If there were a fundamental problem with securitization in and of itself it would have been exposed when the program originated, not 30 years after its inception. The reality is securitization is not in and of itself a bad financial tool. Instead, the sum total of numerous inter-related issues such as the repeal of Glass Steagall, record low interest rates, a compromised ratings system and lack of oversight rather than are to blame, not merely "securitization".

Finally, let me end by pulling the lens back to a much broader macro-level view. Over the last two years there has been an understandable criticism regarding the people who created this situation -- namely, the upper echelons of the financial sector. Many of the people involved in this sector made many mistakes which we are now paying for. The mistakes were large and spread into many areas of the economy. They are one of the primary causes of the current recession. Additionally, the system as a whole -- its overall organization -- needs to be significantly restructured to prevent this situation from happening again. As I have pointed out, the current mess is the combination of numerous factors, not merely one boogie man called "securitization."

But that does not mean that finance in and of itself is evil or that all people involved in this area of the economy are corrupt. I have often read the criticism that "The US doesn't make thinks anymore" as if creating financial structures is somehow less valid than making a physical good. In fact, both activities are equally valid and should be treated as such. Individuals who prudently manage other's money and take well-thought out risks provide a valuable service to the economy; they should not be publicly vilified because other members of their profession have made huge mistakes. In essence, there are good practitioners and bad practitioners in any profession; but the presence of bad practitioners does not nullify the contributions of the professions as a whole.

In addition, many finance people provided invaluable advice to their clients throughout this recession -- advice which preserved their client's money during an incredibly difficult time. Market watchers such as Barry Ritholtz, Mish Shedlock and Tim Iacona all provided invaluable advice to their clients and the public at large. Yet the criticism of finance groups all people in this industry together -- or provides asterisks and caveats regarding industry professionals who are agreed with while still spilling a fair amount of bile at the industry as a whole. Throughout this recession I am often reminded of the public's attitudes about criminal defense lawyers -- a profession which is ridiculed and roundly criticized on a regular basis until you need one. Then you can bet your bottom dollar that you want Johnny Cochran at your side saying, "If the glove does not fit, you must acquit." The point is broad brush strokes about any profession are inappropriate at best.

In short, Dr. Krugman's analysis is wrong. Securitization has provided many benefits to the economy as a whole. It is not the sole problem with the current situation; we arrived at out present crisis because of a combination of numerous ill-thought out events and decisions. Finally, finance is not in and of itself bad and not all "wizards were frauds." Securitization has been around a long enough time to indicate that properly done it does not pose a threat to the economy as a whole. The current mess is not solely caused by securitization, but instead a combination of many inter-related events.

In short, I respectfully disagree with Dr. Krugman's analysis.


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Neoliberals have cooped democracy, and at the head of this is the financial community.  Don’t be fooled by the rhetoric, the system is about profits.  It aint the words or legislation, but actions which reveals the shadow government.  As Aristotle observed:  “A democracy exists whenever those who are free and poor are in sovereign control of the government:  an oligarchy when the control lies in the hands of the rich and better born.

For the best account of the Federal Reserve  (  One cannot understand U.S. politics, U.S. foreign policy, or the world-wide economic crisis unless one understands the role of the Federal Reserve Bank and its role in the financialization phenomena.  The same sort of national-banking relationships as in our country also exists in Japan and most of Europe. 


These International bankers and Rockefeller-Standard Oil interests control the majority of newspapers and the columns of these papers to club into submission or rive out of public office officials who refuse to do the bidding of the powerful corrupt cliques which compose the invisible government -- Theodore Roosevelt, New York Times, March 27, 1922

Teddy Roosevelt's advice that, "We must drive the special interests out of politics. The citizens of the United States must effectively control the mighty commercial forces which they have themselves called into being. There can be no effective control of corporations while their political activity remains."