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Securitization: A Financing Vehicle for All Seasons?

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Abstract

Securitization is considered to be one of the biggest financial innovations of the last century. It is also regarded as both a catalyst and a solution to the 2008 financial crisis. Once a popular method of financing the mortgage and consumer credit markets, aspects of the global securitization market are now struggling to revive. In this paper, I discuss the role that ethics played in securitization prior to the 2008 financial crisis and find that it is not an obvious story of moral failures, but rather that it lies in more subtle elements of the financial system. The ethics uncertainty role in the securitization story is one of flawed incentives and the shifting of responsibility for handling risk. The role of securitization and the ethics of risk transfer have rarely been discussed explicitly in the literature. The historical origins of securitization and lessons learned from previous flawed uses of the process are also provided. I also detail the various global institutional reform proposals that have taken place. Moving forward, it is crucial to understand the causes, consequences, and ethical implications of securitization in the financial crisis so as to help individuals and managers better assess risk, align incentives, and design appropriate policy responses.

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Notes

  1. John Authers, Banks Can’t Lend if They Can’t Find Borrowers

  2. “BoE Policy Makers Backs “bogeyman” of bundled debt,” Financial Times, December 10, 2013

  3. The Oxford Dictionary of Quotations, Partington, Angela (ed), Oxford University Press, 1992.

  4. A staff report at the FRBNY defines a shadow bank as “financial intermediaries that conduct maturity, credit and liquidity transformation without explicit access to central bank liquidity or public sector credit guarantees”. Examples of shadow banks include hedge funds, REITs, ABCP conduits, automobile, and equipment finance companies.

  5. Too Big to Swallow, The Economist, May 2007.

  6. Mortgage Daily.Com http://www.mortgagedaily.com/MortgageGraveyard.asp. Last accessed May 4, 2014.

  7. Factbox – European, US Bank Writedowns, Credit Losses. Reuters February 24, 2011.

  8. SIFMA, 2014.

  9. Eurozone securitization reaches crisis low, Ralph Atkins, Financial Times, November 19, 2012.

  10. Smith, David (2010) The Age of Instability

  11. World Finance, July/August 2010

  12. FCIC Report

  13. Why Can’t the Banking Industry solve its Ethics Problems? Neil Irwin. New York Times. July 30, 2014.

  14. “Banks Seek to Revive Mortgage Bond Market,” Financial Times, August 6, 2014.

  15. US Accuses S&P of Fraud in Suit on Loan Bundle, Andrew Ross Sorkin and Mary Williams Walsh, New York Times, February 4, 2013.

  16. US Accuses S&P of Fraud in Suit on Loan Bundle, Andrew Ross Sorkin and Mary Williams Walsh, New York Times, February 4, 2013.

  17. Although the Enron transactions were not actual securitizations

  18. The author thanks John Boatright for this conversation.

  19. These Bonds Aren’t Peanuts by Jen Wieczner, Fortune.Com. April 7, 2014.

  20. The Eurozone target is 60 %.

  21. A medieval credit market, (Kohn 1999; Hocquet 1995; and Munro 2003) the compera was based on expected tax receipts.

  22. “Instruments of Destruction”, Frank Partnoy, NYTimes, Room for Debate, April 27, 2010.

  23. Financial Times, July 7, 2009.

  24. In September 2010, the Federal Deposit Insurance Corporation (FDIC) passed a “safe harbor rule” which includes a 5 % risk retention and this is the only US risk retention ratio that has been finalized at the time of writing.

  25. Various alternatives have been suggested with respect to what is retained. Is it the equity or first loss tranche, vertical slices (equal amounts of each tranche), or representative sample of underlying loans?

  26. Public comments on the Basel III securitization reforms closed on March 15, 2013.

  27. The minimum total capital has increased from 8 to 10.5 %.

  28. Appetite for French and Spanish bonds remains solid. Financial Times, October 20, 2011.

  29. “Banks Seek to Revive Mortgage Bond Market,” Financial Times, August 6, 2014.

  30. Remarks made before the American Securitization Forum on Feb 2, 2010. “Securitization, “Skin-in-the-Game” Proposals, and Minimum Mortgage Underwriting Standards.

  31. “BoE Policy Makers Backs “bogeyman” of bundled debt,” Financial Times, December 10, 2013

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Acknowledgments

The author wishes to thank: John Boatright, Gary Munro (the Section Editor), Tom Berglund, Praveen Malla, seminar participants at the Hanken School of Economics, Finland and participants at 18th IESE Business Ethics Symposium, Barcelona, Spain.

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Correspondence to Bonnie G. Buchanan.

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Buchanan, B.G. Securitization: A Financing Vehicle for All Seasons?. J Bus Ethics 138, 559–577 (2016). https://doi.org/10.1007/s10551-015-2636-y

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