1- Explain the role of securitization in the current financial crisis.

Securitization is the process through which an issuer creates a financial instrument by

combining other financial assets and then marketing different tiers of the repackaged
instruments to investors. An example of the securitization is Mortgage-backed securities, in
which it emerges by combining mortgages into one large pool, the issuer can divide the large
pool into smaller pieces based on each individual mortgage's inherent risk of default and then
sell those smaller pieces to investors.
The process of securitization creates liquidity, it will enable smaller investors to purchase
shares in a large pool. For example, using the mortgage-backed security, individual retail
investors are able to purchase portions of a mortgage as a type of bond. Without the
securitization of mortgages, retail investors may not be able to afford to buy into a large pool
of mortgages.
The role of securitization in the financial crisis
Securitization was meant to disperse risk associated with bank lending, to some stable
investors who were in a capacity to absorb the risk instead, the risks were directed to the
banking sector and the financial intermediaries. The reason was that banks wanted to increase
their leverage in a way that they would increase their profit in the short run. Investors had
believed that through securitization, credit risk would be dispersed.
Securitization played a role in the crisis in that it opened up new source of funds and tapped
new creditors. This led to doubtful loans on the balance sheet at a time when the economy
was on the downturn. Financial intermediaries had almost all their wiped out while the
financial investors suffered losses.
Motives for securitization is as below

Raise funds and liquidity and reduce financing costs

Transfer credit risk off balance sheet
Capital relief: decrease regulatory and market required capital
Risk management flexibility
Interest rate
Liquidity
Credit risk
Profit opportunities
Intermediation profits vs. long-run warehousing

Securitization allowed for lenders to make loans available to riskier borrowers, simply by
generally expanding the supply of credit. When originators could securitize their loans, they
had a new source of finance for loan origination. The result could have been a reduction in the
cost of credit that led to a credit expansion. With lower borrowing costs, households will on
average borrow more. Moreover, the lower cost of credit may have made lending to riskier
borrowers profitable, resulting in more subprime lending

mortgages were granted to people with little ability to pay them back, and was also designed
to systemically default or refinance in just a few years, depending on the path of house prices.
There was the securitization of these mortgages, which allowed credit markets to grow
rapidly, but at the cost of some lenders having little, contributing to the deterioration in loan
quality. Some securitized mortgages were rubber-stamped as AAA by rating agencies due
to modelling failures and, possibly, conflicts of interest, as the rating agencies may have been
more interested in generating fees than doing careful risk assessment.
Asset securitization allowed for assets to be placed in off-balance-sheet entities, therefore
banks did not have to hold significant capital reserves against them. The regulations also
allowed banks to reduce the amount of capital they held against assets that remained on their
balance sheet, if those assets took the form of AAA-rated tranches of securitized mortgages.
Thus, by repackaging mortgages into mortgage-backed securities, whether held on or off their
balance sheets, banks reduced the amount of capital required against their loans, increasing
their ability to make loans many fold.
All this loop holes allowed for the failure of the likes of Fannie Mae, Freddie Mac, and
Lehman Brothers, which invested in the securities created out of these mortgages, which had
its toll on the capital markets and thus caused the worldwide recession. Standing behind the
collapse of the investment banks and the GSEs was the systemic failure of the securitization
market, which had been triggered by the popping of the overall housing bubble, which in turn
had been fuelled by the ability of these firms, as well as commercial banks, to finance so
many mortgages in the first place. The severity of the resulting recession and its worldwide
scope has been magnified by the huge decline in lending by commercial banks, including not
just BNP Paribas, Citibank, Royal Bank of Scotland, and UBS, Bank of America, J. P.
Morgan Chase, and others, such as Wachovia, IndyMac, CIT Group, that no longer exist. All
these banks had been huge buyers of subprime mortgages.