Sundays are a good time to look at some of the academic literature out there. Reader Mike R. sends along this study from Q1 2009 — revised January 29, 2010 — that looked at the “asset-backed commercial paper conduits” a/k/a securitized paper.

Recall the basic idea behind securitization structured finance: It is supposed to distribute risk by aggregating various debt instruments into a large pool, which is then sliced and diced into various tranches of different risk quality (and yield). Risk is supposed to be spread amongst investors, who purchase the tranches they desire based on the degree of risk (relative to return) they want to undertake.

This assumes, however, that there is an honest attempt to structure these securities in order to spread the risk. It is quite possible to create a structure that willfully aims at more nefarious goals.

But that is precisely what occurred during the run up to the financial collapse: Securitization was used to accomplish the opposite goal — namely, to concentrate (rather than disperse) risk. These structures did so by lowering capital requirements.

That is the conclusion of several NYU and Federal Reserve Board researchers who studied the issue. According to Viral V. Acharya, Philipp Schnabl and Gustavo Suarez, that is precisely what occurred:

We analyze asset-backed commercial paper conduits which played a central role in the early phase of the financial crisis of 2007-09. We document that commercial banks set up conduits to securitize assets while insuring the newly securitized assets using credit guarantees. The credit guarantees were structured to reduce bank capital requirements, while providing recourse to bank balance sheets for outside investors.

Consistent with such recourse, we find that banks with more exposure to conduits had lower stock returns at the start of the financial crisis; that during the first year of the crisis, asset-backed commercial paper spreads increased and issuance fell, especially for conduits with weaker credit guarantees and riskier banks; and that losses from conduits mostly remained with banks rather than outside investors.

These results suggest that banks used this form of securitization to concentrate, rather than disperse, financial risks in the banking sector while reducing their capital requirements.

A few interesting charts in the paper are worth exploring:

The first is a comparison of Modern Banking – with and without risk transfer during Securitization:

Modern Banking – Securitization with/without risk transfer

The second looks at what happened to Commercial Paper after new accounting rules (The Enron Capital Rule) for “liquidity enhancement provided to conduits” went into  effect April 2004.

Total Asset-backed Commercial Paper Oustanding

Quite fascinating.

You can download the full paper here.


Securitization Without Risk Transfer
Viral V. Acharya (London Business School – Institute of Finance and Accounting; Stern School of Business; Centre for Economic Policy Research (CEPR))
Philipp Schnabl (New York University, Stern School of Business)
Gustavo Suarez (Federal Reserve Board)
Date originally posted: March 22, 2009
AFA 2010 Atlanta Meetings Paper

See also:
Recent Policy Issues Regarding Credit Risk Transfer
Federal Reserve Bank of San Francisco
Number 2005-34, December 2, 2005

Category: Bailouts, Credit, Derivatives

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.

8 Responses to “Securitization Concentrated Financial Risks”

  1. cognos says:

    Securitization was (and is) mainly driven by REGULATORS desire for “rated product” as a means to understand portfolio exposures, especially of insurance companies.

    This is silly and tragic. There is nothing worrisome about holding “whole loans”… they carry at 6-8% and have some credit losses… but over time interest tends to far outstrip credit losses.

    Regulators would rather incent large companies to hold highly technical “AAA” securities… despite the crisis potential. I fear this impetus is increasing in the current environment.

    We need more good “philosophy” and “judgement” in our regulators. We also need companies to be able to fail because of poor individual decisions (prop trading) not simply ALL suffer the same fate in a systematic crisis because they “followed” a narrow set of rules. Volker’s “rules” seem to completely miss this point.

  2. Marcus says:

    The chart on “Modern Banking” in the piece on ‘Securitization Without Risk Transfer’ is a little confusing. The first chart from this article has a listing – ‘Bank Balance Sheet’. That chart has two columns, one is marked assets and one is marked liabilities. Nothing is found under assets (consistent with the sad shape of many banks), but the liabilities column lists deposits and capital. Not being an accountant, I am confused. I thought deposits and capital are assets.

    Even more confusing, ‘liabilities’ are listed on the right, and the ‘assets’ column is on the left side of this balance sheet.

    Consulting an authority on this subject, the Bean Counter’s Accounting and Bookkeeping “Cheat Sheet”, debits go on the left and credits go on the right.

    So if deposits and capital are credits, the chart is wrong, and the headings are reversed. However surely I must be wrong. Authors from the London School of Economics, Stern School of Business at New York University, and the Federal Reserve Board, could not make an error like that. We must have redefined the structure of a balance sheet, or reclassified deposits and capital.

    Pity if that is true, because I only know one accountant joke and now must discard it.

    “A very respected accountant was facing retirement. He had served loyally for 40 years, and in that long and distinguished career never misplaced or misreported a single penny. However, early in his career colleagues had noticed a foible.”

    “Every morning when he arrived at work, the gentleman opened his top desk drawer, lowered his head over the drawer, and mediated for a full two minutes. Then he closed the drawer and started the day.”

    “After celebrating the retirement of this beloved friend, his coworkers were sad to start a new week without him. But many decades of curiosity could now be satisfied, what accounting secret was hidden is in that drawer?”

    “A large assemblage of accountants crowded around his desk early that Monday morning while the head of accounting opened his desk drawer to see what accounting mystery it held. The group listened with rapt attention as she read the small note taped inside his top drawer!”

    “Debits on the left, Credits on the right.”

  3. Mr.E. says:

    @ Marcus:

    The simple version …

    Liabilities are what you owe and /or are your sources of funds. The banks owe the deposits to the depositors and capital to those who lent them that money. In essence they are thee “loans” the bank took out.

    Assets are those things you acquire with your liabilities and what others owe you. In this instance “Loans” are those made to others (e.g., consumers) which are to be repaid with a positive return in the form of interest, so they are assets (contracts) the banks hold.

    The left-right debit-credit would be the way to make entries into a a double entry accounting system within each major category (assets & liabilities). Typically on a balance sheet Assets are shown before Liabilities (either left-right or vertically), with the difference being the owners equity.

  4. willid3 says:

    Marcus I think the new and improved version of banking does remove assets as only loans are those for a bank, and they transferred those to that conduit to be securitized

  5. Marcus Aurelius says:

    So, let me get this straight: The banks and ratings agencies foisted, by means of fraudulent valuations and ratings, very risky pseudo-investments onto buyers who purchased those “investments” based on the assumption of accurate risk/reward being reflected in the ratings? You say they’re losing money?

    Ya don’t say.

  6. cognos says:


    The vast majority of this stuff was not “fradulent”. Financial markets involve highly uncertain futures. The crisis of 2008 and the bursting of the housing bubble caused prices to decline to very low levels. AAA bonds declined to 50-70 cents on the $. Lower quality bonds dropped much lower and became what many call “toxic” or “garbage” collateral.

    These events were unforeseen and largely unpredictable.

    By the same token… credit bond indices are UP 50-100% over the past year. Most AAA bonds are back from 50-60-70 to 85-90-95. Some are back to 100 and almost all paid coupon the entire time. I just noticed that Lyondell Chemical received an increase buy-out offer over this weekend. This company went bankrupt, was a levered LBO deal, and represents the worst of what people call “toxic” “garbage”. Its bonds bottomed at 7-cents on the $ last Feb/Mar.

    Friday the bonds traded above 80 cents and will go up, likely above 90-cents on Monday in light of the weekend news. THIS IS A >1000% return to exactly the stuff you are calling “fradulent” “risky” “pseudo-investments”. One year ago… you might have said, “Goldman raped their clients selling Lyondell bonds at 100 and now they are selling them 7.” But if you bought them at 7… you’d be up 12-15x your money. Goldman just wants to play middle-man and facilitate trading. Its each investors job to choose what they buy/sell.

    The future is uncertain. This is the nature of risk/reward and investing. (And dont get carried away with the “casino” risk aspects… a diverse 1/3 stocks, 1/3 bonds, 1/3 cash portfolio with steady additions hardly ever loses 10%).

  7. Winston Munn says:


    For a few elite banks, assets are held off-balance sheet in SIVs and are valued by crossing of fingers and the reading of tea leaves while liabilites represent the amount of taxpayers loss if the crossed fingers bit doesn’t work out.

  8. Simon says:

    Not wanting to skite

    But I’m reading the section on banking in Wealth of Nations by Adam Smith and really it’s worthwhile. Nothing much is new under the sun. Fractional reserve banking has had the same benefits and difficulties since it was first tried.

    I mean it’s not difficult to imagine the problems when you consider that these institutions are allowed the print, by loaning into existence 90% of the money. I say the money because it’s not theirs. Especially not now. Not with TBTF

    TBTF simply means the ignorant plebs who don’t know how banks work and the rest of us are in the hock to the wankers who pay them selves squillions of dollars of our money. What a great scam!