Financial (in)Security?

Financial (in)Security?

Is securitization a boon or a bane?

Securitization is one of those five-dollar words that gets leaves people scratching their heads. It’s been alternately described as the greatest financial innovation since double-entry accounting or as the worst banking product since the Bombay-based call-center.

Securitization is just what it sounds like: it takes ordinary loans and bundles them up into securities. It’s been around a long time, as long as banks have been selling loans to one another. In the 1850s, during the California Gold Rush, westward expansion led to a boom in railroad construction. This required money, and by the middle of the decade there was over $400 million in outstanding railroad bonds, many of which were mortgage bonds—secured by the railroads’ land. When land values declined, the bonds defaulted, leading in part to the Financial Panic of 1857.

But most bonds are quite safe: Treasuries, Municipals, Corporates. The US has a bond market worth some $15 trillion. Just about any cash stream can be securitized. Music fans may remember Bowie bonds: royalties from his albums were so stable that Prudential bought bonds based them in 1997

Only a small portion of our bond market—sub-prime mortgage loans—got into trouble in 2007-8. But the risk of that sector was concentrated in a few critical financial institutions, which fell like dominos: Bear Stearns, Fannie Mae, AIG, Lehman. The ensuing financial crisis led to a huge recession, the effects of which are still with us. This has made many investors and regulators shy of the whole securitization process.

But when you fall off a horse, often the best thing to do is to get right back on again. The problems of the financial crisis weren’t the techniques, but the assets to which they were applied. At its heart, securitization moves money from where it is to where it’s needed. Until financial engineering is as trusted as civil engineering, our economy won’t grow as well as it could.

Douglas R. Tengdin, CFA
Chief Investment Officer

Follow me on Twitter @tengdin

By | 2012-10-15T10:14:07+00:00 October 15th, 2012|Classical Investing, Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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