Explain securitization and how it relates to the global financial crisis?

When an organisation lends money it makes a legal charge on an asset ie the house for a mortgage. This is of value as the house could be sold and the bank receives interest payments relating to the debt. Over a period of time there could be thousands of such debts and the organisation may decide to sell a "parcel" of these to raise capital for other things or to improve the liquidity in its balance sheet. This is called securitization.



The global problems arose when some US companies lent money for houses to people without the ability to continue mortgage payments (it was called trailerpark lending) on the promise that the mortgage could be renewed at favourable interest rates (less than rent) and falsely inflated the values of the properties thus increasing the debt of the customer. They then securitized the lending but the value was much less than they claimed and when the property values fell, people defaulted as the debt was more than the value of their property and the banks who had purchased the parcels in good faith found that they were sat on useless paper( assets were much less than the expected value). This reduced the value of their balance sheets and also reduced their liquidity which led to distrust in the financial community as no-one knew which bank was sat on reduced value assets. The lending lines between banks were based on good faith but these were cancelled as no bank wanted to be pulled under due to the failure of another. This created a situation where credit disappeared from the system so the banks could not lend to their own customers.



It gets a bit more involved but I hope that answers your question.Explain securitization and how it relates to the global financial crisis?
Hello,

When I finished answering your question, I realized it was thorough, yet extensive.

Here is an answer to your question in fewer words -

Securitization involves turning debt into investments. The larger the debt, the larger the investment, the larger the loan for the recipient and the larger the return for the investor. The investments can also be sold, thus the larger the commission for the seller.

Large debts. Large bets. Deferred risk by selling to someone else. Large commissions by selling to someone else. Large, unwise transactions. Not nearly enough money to pay for them. Bankruptcies, foreclosures, bailouts, and inflation. The global financial crisis.

For a more thorough explanation of the securitization and its relation to the global financial crisis, here is a summary of the Inside Job, the documentary by Charles Ferguson about the GFC - which explains securitization - http://bit.ly/kV3fnQ

On behalf of The Global FC Zone,

Crisis to Profit.

Roth