Since the credit crisis began, I have frequently found myself in agreement with Paul Krugman. Not everything, but for the most part, especially on many major points, we are sympatico: He has been correct about Moral Hazard, about the folly of these many bailouts, about the advantages of nationalizing the banks. And, I suspect he is right that the economy would benefit (short term) from a bigger rather than smaller stimulus.

Where we part ways is on his criticism of Securitization. I simply do not see it as a proximate or even secondary cause of the crisis and collapse. It is a tool, and whether it is used for good or evil is a function of too many things beyond what its purpose is.

First, lets go to the professor’s Friday column, then see where we part ways:

“Underlying the glamorous new world of finance was the process of securitization. Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans — all went into the financial system’s juicer. Out the other end, supposedly, came sweet-tasting AAA investments. And financial wizards were lavishly rewarded for overseeing the process.

But the wizards were frauds, whether they knew it or not, and their magic turned out to be no more than a collection of cheap stage tricks. Above all, the key promise of securitization — that it would make the financial system more robust by spreading risk more widely — turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.

Sooner or later, things were bound to go wrong, and eventually they did. Bear Stearns failed; Lehman failed; but most of all, securitization failed . . .

A quick definition before proceeding further:

“Securitization is a structured finance process that involves pooling and repackaging of cash-flow-producing financial assets into securities, which are then sold to investors. As a portfolio risk backed by amortizing cash flows – and unlike general corporate debt – the credit quality of securitized debt is non-stationary due to changes in volatility that are time- and structure-dependent. If the transaction is properly structured and the pool performs as expected, the credit risk of all tranches of structured debt improves; if improperly structured, the affected tranches will experience dramatic credit deterioration and loss.¹

Under normal circumstances, securitization works fine. But the 1998 – 2008 period was filled with all manner of aberrational issues. Much of that era terribly skewed financial activity. Consider:

-Fed Chair Alan Greenspan took rates to 1% — so low as to cause an enormous credit bubble;

-The Fed refused to supervise/regulate the new “innovative” mortgage lenders. Hence, millions of ill advised loans took place;

-For most of history, credit transactions were based on the borrowers ability to sevice the debt (i.e., repay the loan); For a 5 year window (2002-07), that no longer mattered. What dominated the lending decision was the lenders ability to sell the loan to Wall Street; Hence, the lend-to-securitize model was born;

-These firms sold mortgages to Wall Street with an unconscionably short warranty: They guaranteed these mortgages would not default for a mere 90 days. This removed the lenders incentive to find qualified borrowers.

-AAA: The major rating agencies (Moody’s, S&P and Fitch) failed to perform their functions. These firms were wholly corrupted by their new business model of getting paid by underwriters, as opposed to the bond buyers. This pay-to-play model is little more than good old fashioned “Payola.” They slapped a Triple AAA rating on pretty much anything they could get a fee on.

-Without these AAA ratings, most of this paper could not have been sold to the various funds, central banks, and SIVs that bought them;

-Credit Default Swaps on the securitized products were wholly unregulated.

All of the above is painfully detailed in to Bailout Nation.

Do not forget that Securitization had been around for decades without major problems. And over the entire period of time in question, credit card loans, auto financing, and student loans were securitized without incident (other than expected cyclical recessionary downturns).

The same can be said about derivatives. Handled properly, they are tools that serve a function. Let loose with no regulation/supervision/transparency/reserve requirements,  you have the making of a disaster . . .

We can even say the same about Mortgages.  Would you draw the conclusion that because the lending industry made so many bad loans, that mortgages were the problem, and therefore we should do away with them? You have to look at the context in which the loans took place.

Securitization is no different.

Under normal circumstances, it works fine. And if we tweak a bit around the edges — make sure that securitizers cannot shed liability as easily as they have, and adjust incentive compensation away from the current hit & run style of faux profits but real bonuses, Securitization will work just fine.


The Market Mystique
NYT, March 26, 2009

1. Raynes, Sylvain and Ann Rutledge, The Analysis of Structured Securities, Oxford U Press, 2003, p. 103 via wikipedia

Category: Bailouts, Credit, Derivatives, Federal Reserve, Legal, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

82 Responses to “Paul Krugman is Wrong About Securitization”

  1. AndrewW says:

    Nice logical, fact-based critique. I hope he reads it and modifies his position.

    I work in Aviation and securitization (EETC,…) has worked well as a means to finance aircraft for many airlines around the world. Given that most airlines have poor credit ratings, you could almost view this as “sub-prime done correctly”.

  2. Byno says:


    I read that article and came to the exact opposite conclusion you do. To my eyes, Dr. Krugman is singling out credit enhancement and a decline in the quality of subordinated debt as the prime mover, not the process of securitization itself. Borrowing $100 with only $5 in collateral exacerbated the problem, as you detail in the rest of your post. In fact, it’s the sentence immediately after the one you have underlined that succinctly sums up the points in your post:

    “Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.”

    As we’ve talked about before, securitization is old, but it isn’t that old, and it only mushroomed following our favorite piece of legislation.

  3. not give his ilk any ideas, though they, already, have this one, he might as well blame Guns for Crime..

    he should Grow a set, start being productive, and start asking about The FedRes and our Opaque window into its activities..

    “Securitization dun it” is a Straw Man that, merely, sounds intelligent due to a six-syllable word..

  4. donna says:

    Well, it is a lot easier to kill more people with an automatic than a single shot revolver.

    I hate that any time I get a car, mortgage, whatever, it ends up with GMAC, a company I loathe. I would far rather give the samller banks and credit unions my money than them. So I do now. Credit unions have gotten all my smaller loans for years now.

  5. dsawy says:


    I think you and Krugman are ships in the night on this issue.

    First, yes, I’ll concede that TYPES of securitization have worked for decades in the debt markets, in particular the RMBS market. Look at how Fannie created the idea of “conforming” loans in order to be able to sell secondary mortgage debt to obtain money to then push down into the mortgage system in the US. This form of securitization worked well, mostly because it INCREASED liquidity and commoditized mortgage debt.

    What didn’t work well were CDO methods of securitization. Here, there was no “conformity” — there was an incomprehensible mish-mash of prime, sub-prime and derivative nonsense packed inside one security. These instruments served to DECREASE liquidity and de-commoditized mortgage debt. This was bad.

    I’ll give you an example from the ag markets as to why the classic Fannie conforming loan securitization is/was good, and the CDO’s were bad. Corn, beans, etc – all are sold and traded with commodity contracts, etc. The reason why is that we have standards for the product behind the contract – eg, a bushel of corn is 56lb test weight, 14% moisture (or less), and deliverable at certain well known points.

    Take my old business — hay. There are no futures for hay. Hay is bought and sold in individual lots, with individual testing, in various sized packages, with very little conformity to any standard. As a result, there is no futures market, even tho it is the third largest crop bought/sold in the US on a dollar basis. Cotton is a smaller market, yet it is commoditized. It is largely impossible to hedge or forward contract in the hay market (unless you’re doing it on a private contract basis) because of this. Risks are just what you’d expect in a pure “cash on the barrelhead” sort of market – immediate and at the point of sale.

    With CDO’s, Wall Street moved against over 100 years of historical trend in creating instruments that were less liquid. Wall Street has been working for over a century to increase liquidity and uniformity, not decrease it. Why Wall Street decided to get an attack of the stupids and go against 100+ years of historical trend with the CDO’s is something that someone should examine in a scholarly way and prevent a re-creation of this particular bit of stupidity. Likewise, CDS should be normalized and formalized in such a way that they’re not a bunch of irregular contracts.


  6. Marcus Aurelius says:

    I have to ask: if there is a reasonable chance that the bulk of the underlying debt will be repaid, why is there a need to securitize and distribute it to other “investors” in the first place? What kind of ROI would or could be better than a pool of non-fraudulent, high interest/high return (by investment standards) debt?

    If liquidity is the problem, the loans (or portfolio of loans) could be used as collateral – but this requires transparency, as an informed lender will not lend without ascertaining the soundness of the underlying asset being used as collateral.

    The complexity of the system that manufactures these financial “products” makes transparency improbable in the best of circumstances. Complexity is a breeding ground for criminality (if this was not true, we could very easily determine who had committed fraud and when – there would be far less entanglement). Securitization does not mitigate risk – it masks culpability.

  7. willid3 says:

    i used to be in a captive finance company and we securitized our loans, but we were on the hook for the loans if they went bad, not just for 6 months. but then again we had to actually expect the loans be paid back, and had actually do some due diligence to do that. not sure why some think the CRA had any thing to do with it (other than to get out of their responsibility for this mess maybe). the vast majority of these loans were written by mortgage companies and brokers. and they aren’t covered by it. and it didn’t force banks to write NINJA loans.
    now did some in government have some responsibility? sure, that would be the maestro, the SEC leader, among others. even the chief decider. and some of the regulators who didn’t. nor was it just one party that was pushing home ownership. that was a bipartisan job.

  8. willid3 says:

    the purpose of doing this was to expand the companies ability to lend. if you don’t do this, every company is restricted to what capital they have on hand. the problem is the lender must do their due diligence and must be on the hook for the notes if they go bad for the life of the loan. the debacle we have today is that the mortgage lenders didn’t do part one and weren’t on the hook for the loan past 6 months. and this encouraged theses lenders to do loans they knew could last at least 6 months (so they weren’t responsible for the loans any more). and after that innovation, they stopped doing due diligence at all. and the fraudsters moved in for the easy money

  9. Bob A says:

    Key point is Incentivation… Incentives must have a responsibility component..

    There must be a recourse mechanism for those who take incentives that prove to have been
    based on fraud, irresponsible practices, etc

    There is no incentive to be RESPONSIBLE or ETHICAL in the current ‘Wharton’ model

  10. grumpyoldvet says:

    Barry…normally agree with much of what you write but here I have to disagree. The way I read Dr Krugman is essentially that securitization did not work as promised, reduce risk. Above he writes that banks etc, siced, diced and otherwise split the debts and got the ratings agencies to rated them AAA and that’s the problem with securitizations not that the concept is bad it is how the concept was bastardized. So yes, have to agree with him that securitization did not work.


    BR: I appreciate your argument — but I don’t believe that is the primary reason for securitizing debt

  11. dead hobo says:

    Krugman appears to be quite naive. First, securitization is a tool like a hammer or a chainsaw. Both are eminently useful and necessary in the proper context. Both can also be made into horrible props in a slasher movie. They’re neutral on their own and their goodness or badness depends on the holder.

    Second, money need a place to go. If investors didn’t want to make large amounts available to banks directly or indirectly via securitization, they would just put it another investment of similar utility. His nanny attitude is disturbing.

  12. M.G. in Progress says:

    Under normal circumstances, securitization works fine. You made a strong assumption about “normal circumstances”…

    Moreover it’s not true that securitization spreads the risks. It’s just spread the possible losses, which is something different. Can somebody clearly explain the real added value of securitization? What would it happen eliminating part of it? I believe that most of securitization, which is a kind of churning out activity to produce commissions, just serve the purpose to avoid the normal banking activity of maturity transformation. I am sure somebody is convinced that it’s a great financial innovation which was not used properly. Always the same story: if costs to the society are greater than the benefits why continue with securitization? Securitization has no added value in itself it just add to the profits of somebody lucky one to have passed on to somebody else the possible loss.

  13. sanfran_values says:

    If the main benefit of securitization is that it allows lenders to make MORE loans, then I have yet to see an argument that explains why this is in and of itself a good thing. More is not always better — although, I realize this may be a foreign concept to people in the financial industry. Too little lending and an economy stalls; too much and you get a bursting bubble. I don’t know where the tipping point is, but it seems to me that the risks of securitization outweigh the benefits. Maybe the trick is to limit the amount of securitizing a company can do? I think Krugman’s point is that when banks change their business model from making BETTER loans to making MORE loans, then something is very wrong. It’s about quality, not quantity.

  14. mysterious eggs says:

    Are you trying to say, “securitization works as long as all the assumptions hold”?

    That idea has never delivered us into a mess of royal proportions.

    Let’s put it another way. As long as those cash flows being bundled aren’t identical to each other, perfect substitutes, you’re going to have to create more and more complex justifications that it works. In conclusion, nuclear weapons have been around for a few decades without major problems.


    BR: No, I am saying once the nation went off its rails, all bets were off. The same is true for a derivatives. Handled properly, they are tools.

    Let loose with no regulation/supervision/transparency/reserve requirements . . .

  15. im1dc says:

    Krugman spells out his objection to securitization…”Above all, the key promise of securitization — that it would make the financial system more robust by spreading risk more widely — turned out to be a lie.”

    I didn’t read anything in BR’s post that disproved Krugman’s claim.

    Securitization is exactly like the Phillips Curve, both concepts became widely excepted and ingrained dogma within their disciplines for decades, however, both only worked for a limited time until proven to be flawed. The Phillips Curve was proven to be flawed and Securitization has been shown to be easily manipulated for profit by the unethical.

    Sorry Barry, you are wrong in this case imo.

    Just b/c Securitization appeared to work doesn’t mean it was real, i.e., valid and reliable.


    BR: I not sure that is the sole purpose of securitization. It is a tool that allows increased credit flow.

    Is Horsepower a bad thing in an automobile? When you go to merge onto a highway or a pass a large slow moving vehicle, it serves a purpose. But when an inexperienced 16 year old (like myself) had a 350 HP Chrysler 300, it was dangerous.

    These are merely tools, and we use and implement them is a function of whether we are a well-functioning society . . .

  16. alan wynnewood says:

    The question in securitization seems to be this: Are the risks honestly described, so that “risk sharing” can be rationally participated in? In aircraft, yes. In high-risk mortgages, no. Andrew Cuomo began an investigation of Clayton Holdings, and the due diligence performed by Clayton for several large mortgage securitizers. Testimony revealed that when Clayton (now part of Bank of New York Mellon) found a bad mortgage, and notified the securitizer, the securitizer merely paid the wholesaler less for the mortgage, rather than rejecting the mortgage as unfit. Where did this investigation lead? But wait, there’s more! The defective mortgage information provided to the securitizers was not then provided by the securitizers to the bond rating companies. Massive fraud such as this is the natural first cousin of securitizing mortages which were in part fraudulently underwritten, in part products unpredictable as to their futures (option ARMS). NYT January 27, 2008 by Jenny Anderson and Vikas Bajaj.

  17. wtf, no one’s ever heard of GIGO?

    if you’re putting Hooves into the Sausage Grinder, it isn’t Sausage Grinder’s fault that the Hot Dogs aren’t 100% USDA Prime Beef..


    BR: Thatis an excellent point, Mark.

    One of our working assumptions was that lenders would not knowingly, willfully make loans they knew would default. GIGO for sure

  18. me says:

    I doubt many of you will be buying securitzed debt like what has blown up anytime soon. All of those reasons are good reasons NOT to buy. And fixing that looks more than tinkering.

  19. call me ahab says:

    @ Hoffer- good point- your thought generally follows what Krugman was saying:

    “Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans — all went into the financial system’s juicer. Out the other end, supposedly, came sweet-tasting AAA investments. ”

    Maybe Barry can set me straight- but it didn’t take all the loans to become non-performing to taint the MBS- just some- and therein lies the problem. A small percentage of the loans represented by MBS can threaten the value of all MBS.

  20. Mac10 says:

    Securitization has been the key tool for building the global financial Ponzi/Pyramid scheme that is collapsing even as we engage in this surreal debate.

    So what if it has been used for decades? I can smoke cigarettes for decades – does that make me invincible or a self-deluded moron? This financial collapse has been building for decades – ever since the Monetarists took us off of the Gold Standard and U.S. productivity started declining.

    History will not be kind to securitization. It will be just seen as another way that Wall Street packaged up Main Street and sold it off to foreigners.

    We don’t need more regulation, we just need to enforce the laws we already have. We also need to round up the people who profited from this financial fiasco and put them in jail – post haste – to show the next batch of con artists that there is such a thing as accountability.

    You may think I am a wild-eyed populist, but trust me the mob is right behind me and I can’t get out of the way fast enough…

  21. Kyle says:

    Letting banks use securities to get around their reserve requirements didn’t help the situation either. I remember a chart a while back showing the recent exponential growth in M3… That was sick.


    BR: Yet another example of where things went off track . . .

  22. Steiny says:

    willid3 has it right, securitization allowed credit books to be expanded greatly and actually dropped barriers to entry into the lending business to almost zero, so it became a free for all. The problem with this free for all that happens in every bull market or steady market is that everyone (banks, funds, PE) started sucking this crap up on their books and marking these illiquid POSs higher than what they were actually worth, so everyone started ripping 30% returns….hey, no problem. Everyone did a bunch of research and modeling and came to the conclusion that the probability was very low that these assets would not pay out and if they didn’t the other 5000 CDOs on the books would. This is very similar to Milken’s theory on junk bonds…if I buy 20 junk bonds, one or two will fail but I’ll still make 20% per year. Little did he know that by growing the junk bond business so rapidly in the 80s, that his low probability event became a very high probability event, in essence, he created the fat tail, black swan event. Now imagine that banks, lenders, etc. copied this same model, strategy, except on a global scale, now the black swan events that could “never” happen two years ago are all normal events. I can’t see how we get out of this without 5 or 6 countries collapsing especially in the negative birth rate UK areas, driving the Euro below par with the USD.

    Now what is even worse is that we are attempted to change the accounting standards to “model” these assets better, so here we go again, right back to profitability, at least in the short term. Let me ask you this, if someone drops a huge poop in your office would you rather look at it or hide it behind the wall. To me, it doesn’t matter, there is still a piece of shit in the office.

  23. Groty says:

    Of course securitization is a primary contributing factor.

    It’s easy to analyze the creditworthiness of an individual mortgage borrower. But when hundreds of different mortgages are lumped together to create a single security, a true credit analysis of the security would require analyzing each individual borrower’s creditworthiness. Consequently, the diligence required to do a true, thorough credit analysis of hundreds of individual borrowers underlying each security makes it unecomincal for an investor to buy a securitized “bond”.

    So the investment bankers built in lots of protections for the investor. Each securitization was over-collateralized and credit enhanced (via credit default swaps). That gave investors comfort that even if some of the individual borrowers in the pool did default, they could look to the over-collateralization or the insurance protection to make them whole. Finally, to give investors even more comfort, they asked the credit rating agencies to rate the securities.

    So the securities were over-collateralized, they’ve been analyzed by the credit rating agencies, and the credit is enhanced with credit default protection from a AAA rated insurance company like AIG or MBIA. What can go wrong? It’s clearly a no brainer investment.

    I wonder how many individual $400K mortgages investors would have bought if they’d performed their fiduciary duty and done the credit analysis to learn the borrower behind the mortgage was a migrant strawberry pickers making $18K per year?

  24. ThreeFold Commonwealth says:

    And the Nobel Prize is awarded to Barry. Sound banking principals are age old. The modus operandi of securitization is in essence not compatible with banking. Who is the borrower, what is the collateral, who owns it and what is the principal loaned? These questions’ answers confound our current debt collapse. Since World War II we have seen a steady barrage of loosening banking standards by crony capitalists and their partners in crime….lobbyist politicos. We’ve had 70 years of monetary stimulation pumping the fiscal. The monetary pump is now running like Niagara Falls. Barry don’t kid yourself about “aberrational issues.” The reason to keep banking simple stupid is that someone needs to be able to sound an alarm on a bank heist. Securitization was a long process of white collar criminals mapping the bank, taking down the alarm, confusing the books to amounts taken and bribing the regulators, the cops, the judges, the senate, the congress and ….Barry, do we really think that Warren Buffett was lost to his Moody’s lying about credit standards? If a bank falls in the woods and no one hears it is it a bank robbery? The system was gamed by Wall Street wise guys. It’s the perfect bank heist. Where to? Separation of powers. Political, economic and cultural separate.

  25. DL says:

    Securitization is fine, provided that there is total, complete, and unadulterated transparency. The “bar” should be set fairly low for those who want to sue issuers of securities and the grounds that there was anything at all misleading in the information provided. Additionally, the “bar” on prosecutors to pursue criminal prosecution of people who issue securities should be sufficiently low so as to encourage full disclosure.

    There’s also the related matter of CDS insurance on securitized loans. If we’re going to be in the business of bailing every financial company that is deemed “TBTF”, then those companies should be prohibited from taking part in CDS transactions.

  26. DM RTA says:

    When efficient markets go bust they blame the greedy short sellers. When inefficient markets go bust they decry the lack of oversight. The thing they have in common is going bust. This might seem like an incomplete observation but it is not.
    Securitization works fine until we all change.

  27. HankP says:

    I’m not an economist or a trader, everything I’ve learned is from reading stuff on the internet, but the more I think about it the more it seems that most of the problems we see in business have to do with the abuse of limited liability – that is, insulating oneself from the effects of one’s decisions. Securitization can be misused as just another way of handing off known and unknown problems to others without effective recourse. I understand that there are good reasons that it was developed and used, but it seems that any attempt to regulate has to take into account the desire by people to insulate themselves from the ill effects of mistakes (and in the latest round of problems fraud). Not sure how a decent set of regulations can overcome that basic problem. I see Greenspan talking about “reputation” as being something that will deter excesses, but as we’ve seen there are plenty of people who value reputation far lower then a six or seven figure income (or even higher) for a few years.

  28. willid3 says:

    securitization works but only if the lenders are doing due diligence. the problem is how to ensure that. maybe to be able to execute securitization the lender had to have all 3 rating agencies rate the offering , and if they had some liability for their failings if the loans failed. and the lender has to have been in business and organized the way it is at the time of securitization for at least 10 years. and the lender was liable to buy back the securities if the loans failed at any time during the life of the loan or it has to trade a similar or better loan to make the investors whole. and the lender has to purchase insurance for the investors to make them whole if the lender failed. and nobody but the parties involved can purchase such insurance. and if the lender has a spike in loans going into default or collections or has significant financial difficulties, the lender has to set up an account for the investors.
    also saw this and thought it was very interesting take.

  29. Mike in Nola says:

    Gotta agree with Krugman here, although I read it at 5am.

    I think his point is that securitization induces leverage. If a bank doesn’t have to hold it’s loans, but sells them and then lends out more money in a continuous cycles, it is basically lending out a lot more money than it took in deposits, thus getting around the reserve ratios that it is supposed to maintian. Yes, the bank still has the required ratio, but there are a lot more loans owned by somebody floating around than the reserve requirement called for.

    Essentially, you have fractional reserve lending with a multiplier limited only by the amount of securitization the bank can perform, creating an incentive to make risky loans and sell them off and creating a bubble.

    Yes, regulations can help, but they can also be ignored. Banning securitization is a surer solution.

    I’m sure there are some mistakes here, but I’m fixing dinner at the moment.

  30. Terry says:

    I think that the point Dr. Krugman is trying to make (if I can put words in a Nobel laureate’s mouth!) is that the process of the securitization enables the entity creating the package to hide risk. This is essentially a fraudulently activity, whether or not intentional (and in the home mortgage market, it was generally intentional in my view), aided and abetted by really lousy risk analysis by the ratings agencies (mostly negligence and stupidity, not intentional). In the particular, in the home real estate market, it enabled lenders to pawn off huge risks it knew existed in the loans it was making to unsuspecting third parties.

    So, while securitization may not necessarily be bad, it has so many opportunities to go bad that the best way to prevent future pain may be to shoot the process. I really don’t think regulators or ratings agencies or any other third party can devise a system that will prevent the gaming of securitization that we have seen in the last decade. Better to ban it.

  31. GapClose says:

    When I sign a mortgage or car loan it becomes a contract with whomever the purchase is made. It’s always bugged me that my contract can be “assigned” or securitized without my consent. Too bad that contract isn’t given the same respect given the bonus contracts.

    Securitization may work great in theory which assumes great regulatory action; however, we all know that the “regulated” too soon become the “Regulators” and bend things their way. Better to keep the contract(s) with the primary parties involved. After all, once all the pureeing is done, with whom do I have a contract? Maybe I’ll quit paying my mortgage.

  32. mark says:

    1. Don’t forget Krugman only gets about 800 words from the editors for his columns and we don’t know how much the editors themselves might be responsible for the lack of precision here.

    2. Krugman is rather clearly calling out Alan Greenspan in the bit about securitization and the spreading of risk. In that aspect he is 100 hundred percent correct.

  33. mark says:

    100 hundred percent? When is comes to Greenspan I think it’s not hyperbole to say Krugman is 10,000% correct.

  34. sourcethree says:

    securitization = the finance industry’s application of the concept of instant gratification

    i.e., why hold on to an asset that slowly drips cash flow to you and eats up capital when you can simply capture a quick gain-on-sale through securitization?

    stockholders want earnings growth – securitization was a nice vehicle that enabled banks to deliver that

    and yes, securitization enabled much greater credit growth for the entire economy than would have otherwise occurred, but it had other ‘benefits’ as well for the banks (access to more sources of funding, capital management tool, distributing risk to those better suited for it (sub tranches), etc.)

    but once home prices actually fell, all those models behind the MBS that said that could never happen went bust – oops!

    and the resulting crash of the economy combined with a generally over-levered consumer meant that the problem that started in the MBS world spread to even ‘safer’ classes like credit cards, autos, etc.

    the problem now is, in the last few years securitization provided about as much credit to the economy as simple bank lending did – so with securitization dried up, you have three choices – either:
    – allow it to stay dried up, and suffer a 30%-ish contraction in credit extension/the economy
    – infuse the banks with enough capital so that they can make enough loans to replace the capacity lost from securitization
    – or try to re-create the securitization market

    we’re getting a bit of the last two (via TARP and TALF) as the gov’t tries to cushion the slow-down in economic activity from becoming a complete bust

    those who rail against the gov’t programs are roughly arguing for the first choice – i.e., a depression-like period that clears out excess debt

    the current course of action is likely to moderate the downturn’s depth, but extend any robust recovery further out in time as the debt doesn’t get cleaned out of the system and people stay more highly levered than otherwise

    only time will give a clue as to what the ‘right’ course is

  35. Estragon says:

    Blaming securitizations misses the point. The fundamental problem was the pricing of credit risk based on rising collateral values rather than on the borrowers ability to service the debt, compounded and reinforced by principal/agent issues.

    This has been a key element in the formation of asset bubbles throughout history, long before securitization, and it will be again, even if securitization is banned forever. The details change, but the underlying problem doesn’t.

  36. im1dc says:

    BR says…: “I not sure that is the sole purpose of securitization. It is a tool that allows increased credit flow.

    Is Horsepower a bad thing in an automobile? When you go to merge onto a highway or a pass a large slow moving vehicle, it serves a purpose. But when an inexperienced 16 year old (like myself) had a 350 HP Chrysler 300, it was dangerous.

    These are merely tools, and we use and implement them is a function of whether we are a well-functioning society . . .”

    im1dc replys to BR: The Phillips Curve is a tool as well, yet it is neither valid or reliable, it only appeared to be in certain situations. Do you want to bet the house on the Phillips Curve being correct?

    [BR: The Phillips Curve is not a tool — its a theory. It describes relationships. I don’t think ti can be described as a tool like HP or securitizations or derivatives]

    As for your example, the number of horses under the hood is not the problem, it is the driver behind the wheel. Same thing applies to Securitization, that is once the “lie” was put to paper securitization became a fraud and no longer valid or reliable.

    Unforntunately, recent history has shown clearly that there has been far more lie and fraud in securitization than truth and honesty. That is why securitization’s various forms grew from about$10 Trillion to an estimated $50 – $60 Trillion globally in only 5 or 6 years. So you are correct that securitization is “a tool that allows increased credit flow,” but to what purpose, fraud upon fraud upon fraud ad infinitum?

    Therefore, Krugman is correct, Securitization DID NOT spread risk as promised, it spread fraud.

    Another way to see this is that if Securitization had worked as promised and spread the risk DEFAULT would have been limited to 1 or 2% (historical norms), as was pointed out by another.

    Securitization was and is a Model that flowed from Statistical analysis. All Statistical analyses that model reality are subject to error (flawed) b/c they model an Idealized reality.

    That means, once the Model is known to participants, the participants set out to manipulate/game/fool/exploit the Model. Models being static cannot keep up with the changes. That’s why new models come into being.

    I assume you exploit this vulnerability/inefficiency/flaw to make money in markets today.

  37. Mike in Nola says:

    After rereading things, I think some of the posters after me did a better job of channeling Krugman than I did.

    But I did stumble onto another problem of securitization that is explained much better here:

    The column did not foresee all the havoc that would be wreaked here by the contraction. But I believe he is correct about the China bubble. China is much worse off than most know.

  38. ah693973 says:

    First post here.

    I was thinking about this earlier and I agree with Barry that these instruments are neither good or bad. The problem is that the purchasers believed that their interests were being protected by a competent watchdog. The triple A rating meant that these instruments were “bulletproof” and one did not have to understand them to feel comfortable buying them.

    It really was the worst of all worlds. To have a competent watchdog looking out for your interests would be the best, but barring that, you should at least know that you were on your own when it came to evaluating the risk involved in a purchase. The unsophisticated purchasers of these instruments never had a chance.

    Same thing with Bernie Maddoff really, people thought that they were being looked after by someone more competent than themselves. They let down their guard and were handed their heads.

  39. Steve Barry says:

    Sounds like the debate about guns..guns don’t kill people..people kill people. Both sides are compelling.

    In finance, it is like the argument about fiat currency. Why shouldn’t the government be able to print money at will, without gold backing it? A modern economy does not need to link to the barbarous relic known as gold. Our central bank will use the tool properly…ooops…what’s that? Every experiment of fiat currency in all history has ended in tears? The reason is because you can’t trust anybody to use it properly. I believe the same should be said about securitization. Without it, you would have to take out a loan with a down payment and a job and the bank would check 9 ways till Sunday that you can pay it back. BTW, we would also be better off without that great technological marvel the nuclear bomb.

  40. “Therefore, Krugman is correct, Securitization DID NOT spread risk as promised, it spread fraud.”

    You might as well blame the Phillips-head Screwdriver for poking you in the eye..

    Or, blame the ’28 Cord for being driven as Capone’s get-a-way vehicle..

    IOW, Fraudsters spread Fraud, not “Securitization”..go ahead, keep blaming inanimate objects while the perpetrators go scot-free..

    It’s a hideous Straw Man, a red herring..

    Krugman spins, yet, more Poli-Sci-Fi surreality. He’s, rapidly, approaching “Lysenkoism” in the field of Fin/Econ..

    Securitization can be a tremendously valuable tool for Portfolio duration optimization, at the very minimum..and, can provide multiple facets on Cash Flows, for Portfolio risk shaping, that ‘whole loans’ could never hope to accomplish..

  41. Moss says:

    Securitization and derivatives are certainly both tools. But when taken to extremes they become enablers of fraud and added risk regardless of where they spread. I think Krugman is simply reacting to what they became and that end state was not what they were meant to be.

  42. Simon says:

    Securitization has been used as a way to avoid the necessity of eating your own cooking. Isn’t this the essence of a PONZI scheme? We have heard about having to dance until the music stops etc. The expectation being that when it comes time to sit down there will not be enough chairs.

    This is Fraud! You go to a dance you expect that should there be a power failure you will a) be able to sit down on a chair b) sit down somewhere without suffer bodily harm c) Leave the building essentially unharmed. OK the best dancers get to dance longer and make the nicest looking couples etc that much is fair. How many people would enter the competition if they knew they could come away armless or legless or dead?

    I think information asymmetry is the essential part of wall street’s modus operandi and is essentially the source of most profits. Securitization aids and abets this asymmetry to an unmanagable extent and accordingly should be banned.

  43. flipspiceland says:

    In an ideal world securitization would work as you outline with tweaking the edges. But it is a corrupt world, inhabited by a loathsome minority of moneychangers who buy and sell politicians to gain the asymmetry that Simon above illustrates.

    It should be temporarily banned at least until we evolve a species of human being which will not arrange the deck chairs to assure their own prosperity at the sacrifice of the rest of the human race.

  44. Myr says:

    The proximate cause of the crisis was the explosive growth in total outstanding credit relative to GDP over a period of three decades with the vast majority coming in the past 8 years due to the exponential nature of the growth. When are we going to state the case simply?

    Securitization played a key role, but so did all the other things we keep talking about: issuers paying for credit ratings, stupid ratings companies, laws allowing for vastly expanded leverage ratios, securitization evolving into CDO’s, extremely low interest rates, regulators experiencing sleep apnea, etc.

    If there’s one thing/person/institution to blame, I would blame the Greenspan Fed for allowing the growth in money supply(M3) to grow in an out-of-control fashion. They are the ones who are supposed to control the money supply and they failed miserably.

  45. usphoenix says:

    @Steve Barry: The gun analogy occurred to me, and then I read your comment.

    IMHO it’s more like free booze and drugs. Some can resist or practice circumspect moderation, but the temptations are just too great to resist. There will always be people at the party that can’t say no to temptation.

    It was an open invitation to the worst possible hangover. And guess what? Who exactly was the designated driver? Or had the breathalyzer?

    So, yes, I would definitely agree securitization was a horrible moral hazard that should have never been allowed as practiced.

  46. philipat says:

    Faux profits+Real bonuses=Fraud.

  47. cbosco76 says:


    In your analogy, AAA ratings suggest it’s safe for kids / G-rated?

  48. Greg0658 says:

    Mike in Nola @ 4:57 pm “If a bank doesn’t have to hold it’s loans, but sells them and then lends out more money in a continuous cycles, it is basically lending out a lot more money than it took in deposits, thus getting around the reserve ratios that it is supposed to maintian. Yes, the bank still has the required ratio, but there are a lot more loans owned by somebody floating around than the reserve requirement called for.”
    BINGO in the last sentence “somebody” is not a bank required to hold the standard 10% then exponential growth .. money now grows on trees.

    Steve Barry @ 6:32 pm “In finance, it is like the argument about fiat currency. Why shouldn’t the government be able to print money at will, without gold backing it? A modern economy does not need to link to the barbarous relic known as gold.”
    Sounds like your helping me make points on the World Currency discussion. But I have to draw the line at allowing miners to set levels with gold or salt.

    Having made those two points .. I’m wondering what mechanism without securitization increases the money flow? ….. population growth .. seeds sown efficiently .. widgets made of common stuff now a wow?

  49. Steve Barry says:


    Gold is a great currency for many reasons:

    1) It has been the choice of the populace all throughout history
    2) The supply only grows about 2% a year
    3) It doesn’t decay
    4) It is easily divided into smaller quantities
    5) It is dense…does not take up much space

    Sure sounds a lot better than green paper for currency…especially green paper only backed by debt.

  50. spear says:

    Blaming securitization is ridiculous. People can misuse any tool or capability.

    In 30 years since the first MBS, securitization has lowered the cost of borrowing, reduced the systematic risk, and provided an easy way for companies to manage their balance sheets while increasing investor exposure.

    Sure, the recent spate of assets blew the models, but that was not because the models didn’t work, it was because they didn’t adjust them for the correct assumptions. That isn’t the model’s fault, but the model user.

    If we removed securitization the problem still would have occurred. If we removed the problem, securitization would have been just fine.

    Krugman is looking for a big splash and headlines.

  51. mangler says:

    Once the mortgage products were securitized they were rarely if ever traded. That should have been the first tip off that something was dramatically wrong. Can something be realistically termed a security if there is no market for it?

  52. Chris Whalen says:

    Actually I think Krugman is right. There is no “good sale” and the whole premise of securitization, that you can spread the economics in a loan to various unrelated agents who will do the same job of credit origination and servicing as a local lender is silly. Securitization is a commission opportunity for the dealers and a revenue opportunity for members of Congress.

  53. Mike in Nola says:

    If you think about it, we are really no different than our ancestors. The same threads run through bubbles.

    Most of the examplar bubbles of the past hundreds of years all involved a kind of securitization of the alleged value of a future cash flow. The securities generated were overpriced because of invalid assumptions about the value of cash flows. The mispriced securitizations created the illusion of wealth which led to an increase in money supply through the simultaneous creation of money in the hands of borrowers and offsetting debt. Prices for luxury goods (houses, clothes, carriages or cars, gold and jewelry) rose with overspending by the victims who believed they were really wealthy. Suppliers of these items made profits.

    The culmination of the bubbles generally involved amazing credulityabout various schemes which is laughable in hindsight. Examples are “an undertaking of great advantage, but nobody to know what it is” of the South Sea Bubble or the crazy internet companies with no business model in the Dotcom boom.

    Eventually, there was a general collapse as the underlying values were shown to be false. The same symptoms recur periodically.

    The South Sea and Mississippi bubbles were both based on securities backed by the mythical wealth to be generated from overseas trade. The securities were overpriced but were accepted by the public as valuable, traded and used as either explicit or implied collateral. Many were rich on paper profits and acted like it, raising prices for many asset classes. The effect on the paper rich was similar to the effect on those with big 401k’s in recent times: they felt safe borrowing and living extravagantly.

    The stock market bubbles of the 1920′s and 1990′s were analogous, except that the securities issued were based on alleged future cash flows of public companies. This again created the illusion of wealth, borrowing and high living, e.g. the Roaring Twenties, or the Internet Millionares of the dotcom boom.

    The housing bubble was different in terminology, but used the same principle: securities were based on alleged future cash flows which were ultimately based on implicit value of real estate. Each of the loans created money in the hands of the borrower and an offsetting debt. The borrowers felt rich and used the money to buy stuff, which made suppliers wealthy with profits flowing through the economy. The securitized mortgages were accepted as valuable and swelled the balance sheets of financial institutions who used them as a basis for paying enormous salaries, increasing lending and/or issuing more debt. The paper profits of the institutions translated into increases in the size of 401k’s, which made those owners comfortable spending and borrowing, knowing that they had a big nest egg. And, of course, fortunes were made flipping houses, much like people traded shares of the Mississippi company. All contributied to the bubble. When the prices of real estate did not increase and debtors defaulted, the structure collapsed.

  54. Steve Barry says:

    @Chris Whalen:

    I like the way you put that…I realized the same thing when I heard how a bank that packages loans and sells them thus has the capital to make new loans…sounds a bit Ponzi-ish to me and helped cause a mountain of credit that is crushing us.

  55. KJMClark says:

    I agree mostly with Krugman. You’re right, securitization is a tool, but we have to ask if the benefits are really worth the potential problems. I’d say that the repeal of Glass-Steagall failed as well, for similar reasons. In both cases, the system we had before worked well, the new tools opened new opportunities for both help and harm, and it turned out the harm was much worse than anticipated.

    You used the horsepower analogy, and it works against your point just as well as for it. We’ve had an arms race on American roads because CAFE standards were allowed to essentially lapse. Are we all better off for all the Navigators, Expeditions, Hummers, F350s, etc. on the road? Was life really that worthless before we had them? The downside of all that horsepower and armor turned out to be very high gas prices for everyone, lots of reckless driving, lots more CO2 emissions, etc. and the benefit was another level of social exhibition and the ability to break the law passing other people already speeding in their gas-guzzling mastodonic bling.

    I’d go one step further and add mutual funds to the list of failures. They certainly have value, but the drawbacks turn out to be 1) stocks are supposed to convey both shares of ownership and voting rights, but in reality they’ve removed voting authority from the owners. Mutual funds own large blocks of shares of companies, and tend to vote with the Board. Active owners can’t outvote those blocks easily, so we end up with unaccountable Boards agreeing to excessive compensation. 2) Mutual funds give people the illusion that investing is as easy as pensions, which it never has been. 3) Mutual funds have then given financial interests a convenient foil for breaking up pensions, which were better for most people but not as valuable for Wall Street. So we end up with a system in which executive compensation has become an arms race facilitated by emasculated shareholders and accommodating Boards, and large portions of the population with ruined retirement prospects who can only blame themselves.

    In those cases, and many more from the laissez-faire era, those tools certainly have some benefits, but the drawbacks are apparent and the benefits aren’t worth them. We won’t get rid of them, but hopefully we’ll regulate them down to the niches for which they are really valuable. I think Krugman is mostly right, and I expect we’ll drag this Depression out until no one can stomach financial innovation for a generation.

  56. spear says:


    I’d love for you to prove that they weren’t traded.

  57. spear says:

    @Steve Barry – Do you even understand what a Ponzi-scheme is? There are no assets or real cashflows in a PS, in securitization there is. I love how the hyperbole of PS is now thrown about for anything that people really don’t understand.

    Soon we’ll have people claiming the CERN collider is a Ponzi Scheme merely because they don’t understand physics.

  58. rknox says:

    Complexity is the enemy of reliability. Complex systems can not be regulated because to do so you need complex regulation systems, which themselves are not reliable.

    When I was in grade school our principal had a rule, “If there is trouble and you were there you will be spanked. Doesn’t matter if you were the victim. ” Beauty of a simple rule, it can not be finessed.

    In a political environment, complex rules can be bent by the politically powerful.

    Simple securitization works fine, eg 100 similar conforming loans. But unless you are careful you end up with CDO cubed instruments – totally opaque and completely unreliable, subject to the interpretation of mathematical cons like applying gaussian statistics to non gaussian situations.

    My reading of Krugman was not that he was against securitization per se but that he saw that open ended securitization was deadly.

    Philosophical question – given the dishonesty of our system, how do you define a simple rule that makes simple securitization allowed?

  59. usphoenix says:

    @Chris: perfect.

    KJMClark: Nice expansion. The taxpaying shareholder has been emasculated. And it continues.

    Not only are we stupid and greedy, but we have been acclimated to a dishonest, corrupt financial community raking in the billions.

    Extending a little more, how is it hedge fund managers can rake in billions without seemingly making any contribution to GDP and overall well-being?

  60. spear says:

    @usphoenix – How are they not making contributions to GDP? Are they not creating value by giving companies access to investors that they wouldn’t have in any other case? Are they not using intellectual capital to lower borrowing costs? Doesn’t all of this feed into GDP and giving companies the ability to grow?

    A perfect example would be companies like Avis Budget (rental cars) or PHH (fleet leasing). Both of those companies require securitization to build car fleets to enable tourism (Avis Budget) or allow small/medium/large businesses to use fleets of vehicles (PHH) to carry out their businesses.

    Both of those companies need the intermediation of securitization to finance their businesses, both of those companies have been hurt significantly from the non-functioning of the securitization markets. Both of those companies have valid securitization programs that are not lies and haven’t had ANY problems at all.

    How about Wyndham timeshare (whether you agree with timeshare or not), since they can’t access the securitization market easily they’ve had to cut 30% of their staff, scale back sales, all of which feed into GDP.

    It’s quite easy to take the populist (and ignorant) viewpoint, glossing over reality, it is quite another task to analyze the problem and realize that taking a neandrathalic viewpoint is ignorant, stupid, and dangerous.

  61. usphoenix says:

    @spear: I think the word is “neanderthalic”.

    I guess I am old fashioned. Companies that built long-term relationships with lenders got all the money they needed. There was a relationship that merited the trust conveyed. Debtor knew lender, within the same community, and they were in it together.

    Today we have become far too intelligent, sophisticated, fast-paced and impatient to rely on those tried and true methods when we can anonymize debt and pass it off to unknowing investors and instantly walk away with a fat percentage off the top. Someone usually gets left holding the bag, and that’s fine, so that our CORPORATE AMERICA gets thing’s their globally controlling way.

    Besides the oil emirates have to have a way to channel our billions without traceability.

  62. spear says:

    @usphoenix – Are we going to be the spelling gestapo online?

    I do agree that in many cases there has been too much intermediation in lending, especially in the mortgage area. Depending on brokers who do not really have a vested interest, rather than credit officers at banks, was a horrible idea.

    Too intelligent? Borrowing and risk costs have plummeted in the last 30 years, that isn’t “too intelligent”, that is utilizing resources correctly. That people screwed up in this situation isn’t the fault of the tool. Nobody was making a “fat percentage” off of the top. Underwriting fees were far less than that. Globally controlling way? Please, enough of the hyperbole and populist crap.

    How did this lead to oil emirates? They could hide money in any system. Now you’re reaching for strawman arguments. Stick to the topic.

  63. Hondo says:

    Securitization works as long as the underwriting is sound (which is problematic unless the originator also keeps a portion of the securitization… I have little confidence today that anyone in finance knows how to underwrite correctly)

  64. usphoenix says:

    @spear: Look out, it’s a trap.

    Thanks for taking the bait. Nothing like a lively Sunday morning conversation to get the juices flowing eh?


  65. Anonymous Jones says:

    “It is a tool, and whether it is used for good or evil is a function of too many things beyond what its purpose is.”

    Heroin is also a ‘tool.’ I’m not for making heroin illegal, but I’m definitely in the camp that we should discourage its use, except for those in chronic pain. Some things are too dangerous for widespread use, whether or not they can sometimes be used for ‘good.’

  66. spear says:

    @Anonymous Jones –

    Please, comparing securitization to a drug is just another strawman. There are tons of good things for humanity that has been misused over history, but throwing the baby out with the bathwater isn’t the option.

    Securitization has worked just fine for more than 30 years. It has functioned well, lowered borrowing costs, and provided companies a good way to finance themselves and their activities. People got crazy and shifted how they underwrote business, that isn’t securitization’s fault. Undoubtedly, things need to change, however, securitization itself doesn’t need to change.

  67. spigzone says:

    The problem with securitization is it is inherently dishonest.

    If I sign a mortgage with my local financial institution I should rightly expect all future matters pertaining to that mortgage to reside within that instution.

    It’s really just that simple.

  68. cdskiller says:

    Barry, there are so many misleading statements or specious assumptions and arguments in this piece I don’t even feel it’s worth my time to pick them apart one by one. I know you are smart, which means that you are being a little intellectually dishonest. That’s disturbing. Please don’t ask for my understanding when you find yourself one day mimicking Alan Greenspan and expressing your shock that all your assumptions could be so wrong. Human nature can’t be trusted, Barry. That’s why gun control is necessary. You have to take away the dangerous tools, otherwise they will be used. These securities can be rated responsibly in a rapid enough fashion for the market to function. Only denial and blind trust will work, and that’s why we got into this mess.
    Oh well. I thought you were better than this.

  69. sourcethree says:

    a good article on securitization – both the haters and the non-haters will find something in here to like

  70. impermanence says:

    Securitization is like giving a pound of Hawaiian, three ounces of cocaine, a hundred Quaaludes, and ten cases of beer to a bunch of college freshmen and hoping for a good outcome.

    If I am not mistaken, people go into finance not because they have this great desire to help their fellow man. These people and their ploys need to be made as transparent as is humanly possible.

  71. Chris,

    I appreciate the ‘soft spot’ for the ‘little banks’/’local lenders’, there’s much to recommend them..

    though, the last thing we need, IMO, is to go back to “the ’50s”-era of 3-6-3-land, by itself..

    if that’s going to be the case, at least we should couple it with a page out Syria’s DSE hours of operation-book..(Trading will take place on Mondays and Thursdays, the official SANA news agency said)

    though, in *Reality, we’d be far better served w/ local exchanges/exchange-nodes for multi-(local)point points of physicality overlaying a larger ‘exchange’ backbone..much like ‘local banks’+”securitization”..

  72. cdskiller Says:

    ” there are so many misleading statements or specious assumptions and arguments in this piece …”

    “Human nature can’t be trusted, Barry. That’s why gun control is necessary.”

    “You have to take away the dangerous tools, otherwise they will be used.”


    any idea how your abode was constructed? ever drive an automobile? eat in an Restaurant?

    No? IOW, nice post, too bad one couldn’t even tie a Horse to it..

  73. spigzone Says:

    “If I sign a mortgage with my local financial institution I should rightly expect…”
    “It’s really just that simple.”


    I’ve U$D 100 that says you signed a release of ‘motgage servicing rights’ during your ‘closing’

    remember, Reading Is Fundamental

  74. im1dc says:

    George Soros agrees with my take on securitization not Barry’s ‘it’s only a tool’ metaphor according to my interpretation of:

    “Like Warren Buffett, he thinks that the complex financial instruments used by the banks were economic weapons of mass destruction. If anything he expected the tipping point to come earlier. “Everybody who realised that this was unsustainable expected it to collapse much sooner,” he says. “It is so devastating exactly because it took so long.”

    The urgent task now, he says, is to realise that the system that collapsed was flawed. “Therefore you can’t restore it. You have to reform it.” He worries that politicians have not yet accepted the need for fundamental change and that “a lot of bankers have their head in the sand”. ”

    I think Mr. Soros hit the bullseye here.

  75. spear says:

    RE: Soros. He was referring to CDS and other derivatives. Securitization is not commonly known as a derivative.

    spigzoine: Securitization is not lying, it is merely transferring the loan. Lenders have always sold loans throughout history.

  76. G.K. says:

    It looks to me that Krugman and Barry both agree that securitization, as used in the credit bubble years, was far less than ideal. The question that remains is almost a behavioral one: are humans responsible enough to use these potentially destructive tools in a responsible manner? Or are humans just too self-interested to act in a way that’s responsible. In a lot of ways, though, the question is moot. The irresponsible way in which they were used likely means that buyers will shy away from buying them (absent substantial government support) for a very long time.

    I think some of you are naive. Wall Street used mathematicians and indescribably complicated formulae to construct and deconstruct these securities specifically in order to obfuscate the underlying collateral and potential risks. The point, in fact, was complication. You see, if you could construct something that nobody could actually understand, they couldn’t dispute what they were told or what they read in black and white. Then, combined with the vaunted AAA rating + a high yield, and people, in their greed and desire NOT to know, became willing believers. People can understand a whole loan. Not much issue there. But, these securities were designed to be beyond analysis. All you needed to know was that there was a lot of math involved and that there was a AAA rating. That’s it.

  77. G.K. Says:

    “Wall Street used mathematicians and indescribably complicated formulae to construct and deconstruct these securities specifically in order to obfuscate the underlying collateral and potential risks. The point, in fact, was complication. You see, if you could construct something that nobody could actually understand, they couldn’t dispute what they were told or what they read in black and white. Then, combined with the vaunted AAA rating + a high yield, and people, in their greed and desire NOT to know, became willing believers. People can understand a whole loan. Not much issue there. But, these securities were designed to be beyond analysis. All you needed to know was that there was a lot of math involved and that there was a AAA rating. That’s it.”

    I hope all y’all recognize the Truth when it’s in front of you..b/c G.K. put it, just, there.

    as an aside, it explains why the “Champagne Tower” explanation of ‘how these work’ is, really, just so much mordant BS.
    try def.#2

  78. usphoenix says:

    @GK: Just so.

    “Risk diversification” was nothing more than “risk concealment”. Hide lots of bad under a little good.

  79. shs28078 says:

    Can someone explain to me how gain on sale profits gets reversed? Does it come straight out of comprehensive income? I wonder how much of bank ‘capital’ is retained earnings related to gain on sale profits that have evaporated. How much has been reversed to date, and how much is left out there ticking???

  80. im1dc says:

    “”My Manhattan Project”

    by CalculatedRisk on 3/30/2009 05:02:00 PM

    For your reading enjoyment … here is an article about a software programmer who wrote some of the software for securitizing mortgages.

    From Michael Osinski in New York Magazine: My Manhattan Project How I helped build the bomb that blew up Wall Street

    I have been called the devil by strangers and “the Facilitator” by friends. It’s not uncommon for people, when I tell them what I used to do, to ask if I feel guilty. I do, somewhat, and it nags at me. When I put it out of mind, it inevitably resurfaces, like a shipwreck at low tide. It’s been eight years since I compiled a program, but the last one lived on, becoming the industry standard that seeded itself into every investment bank in the world.

    I wrote the software that turned mortgages into bonds

    Because of the news, you probably know more about this than you ever wanted to. The packaging of heterogeneous home mortgages into uniform securities that can be accurately priced and exchanged has been singled out by many critics as one of the root causes of the mess we’re in. I don’t completely disagree. But in my view, and of course I’m inescapably biased, there’s nothing inherently flawed about securitization. Done correctly and conservatively, it increases the efficiency with which banks can loan money and tailor risks to the needs of investors. Once upon a time, this seemed like a very good idea, and it might well again, provided banks don’t resume writing mortgages to people who can’t afford them. Here’s one thing that’s definitely true: The software proved to be more sophisticated than the people who used it, and that has caused the whole world a lot of problems.”

    With that as prelude here is what I posted at CalculatedRisk today:

    Yea, if only, but the problem is that securitization is flawed precisely b/c it was enthusiastically done to defraud/fool buyers, i.e., not correctly or conservatively.

  81. im1dc says:

    spear Says:…”RE: Soros. He was referring to CDS and other derivatives. Securitization is not commonly known as a derivative. ”

    That is not the way I read the article, Soros’ comments and securitization not being commonly known as a derivative.

  82. spear says:

    im1dc: Please show me where he said “securitization”. Warren Buffet’s comments were directly tied to CDS and other derivatives, not securitization.

    RE: Remainder who rip on securitization and AAA ratings. How come this worked for almost 40 years and rarely any problems?