The Problem with Securitization
James Kwak from Baseline Scenario:
The boom in securitization was based on investors’ willingness to believe what investment banks and credit rating agencies said about these securities. Buying a mortgage-backed security is making a loan. Ordinarily you don’t loan money to someone without proving to yourself that he is going to pay you back (or that the interest rate you are getting will compensate you for the risk that he won’t pay you back). The securitization bubble happened because investors were willing to outsource that decision to other people — banks and credit rating agencies — who had different incentives from them.
Are investors going to go back to that mindset? Do we want them to? It seems to me the rational investor response is this: “I have no idea what is in those securitization trusts. I don’t trust the banks, since they are taking fees out of each deal. I don’t trust the credit rating agencies, since they are being paid by the banks, and don’t have enough staff and expertise to do the job properly. I don’t trust the models, because they’re wrong. There’s no way I can do the analysis myself. So I’m not buying.”
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