Sudip Bandyopadhyay’s Blog

Financial crisis causes lot of damage, and ill-conceived post-crisis measures, no matter how well-intended, can only magnify their effects. Examples abound.  For instance, the Smoot-Hawley Tariff Act of 1930, a US law that erected trade barriers, is widely regarded as having added considerable strain to the world economy after the 1929 stock market crash.  However, the Oscar goes to the British authorities: after the South Sea Bubble collapse (1720) they banned issuing stock certificates for more than a century.  Now comes securitisation.  Granted, many transactions structured around sub-prime mortgages have performed disastrously.  But blaming the current crisis on securitisation in ludicrous.  Unfortunately, there is a real danger that a bad combination of public outrage plus politicians’ ignorance might end up producing just plain bad and counterproductive regulation.  To be clear: securitisation is just a technique to create securities by reshuffling the cash flows produced by a diversified pool of assets with some common characteristics.  By doing so, one can design several securities (tranches) with different risk reward profiles which appeal to different investors.  Of course, an erroneous assessment of the risk characteristics of the underlying assets, the use of faulty models to examine the merits of each tranche, or an imprudent reliance on leverage can lead to calamity.  This is what explains the debacle behind the subprime transactions.  But this is not an indictment of the concept of securitization; it just shows the devil is in the execution.  By creating securities out of illiquid assets, securitisation increases liquidity.  Second, for companies that have assets with predictable cash flows, securitisation provides an alternative form of financing.  And third, lending institutions can use securitisation to manage the credit exposure more efficiently, which, in turn, benefits are critical in a recessionary environment.  Securitisation, if used properly, makes access to credit more efficient.  Let us not make the mistake of fighting the next recession without the benefits of securitisation