Securitization is a process where a financial institution issues a financial instrument by combining different financial assets into one asset. The financial institution later sells these combined, repackaged assets to an investor. This is done to free up capital for originators and can offer opportunities for investors. Regardless, both increase liquidity for the financial institution and the marketplace.
Usually, securitization is closely linked to the world of lending and debt. These financial assets are sometimes called collateralized debt obligations (CDOs), bonds or pass through securities. Securities are also very common in the world of mortgage lending. In the world of home loans and mortgage lending, they are commonly referred to as mortgage-backed securities or MBS. Securities backed by other types of assets tend to be called asset-backed securities or ABS.
In the United States, the government-backed companies Freddie Mac & Fannie Mae purchase mortgages from financial institutions and resells them as securities. This securitization is done in order to encourage financial institutions to provide more mortgages. Hypothetically this can help the real estate market stay healthy and keep home prices affordable.
Securitization can provide certain risks to the market. It may have played a part in the 2008 subprime mortgage crisis. The California Public Employees’ Retirement System or CalPERs sued the rating agencies Moody’s and their rivals for mislabeling securities in 2009. They later settled out of court for $130 million.
Historically, securitization was invented in the Dutch Republic of the 17th century. They became a bit more common by the 19th century with the introduction of railroad mortgage bonds. In the late 20th century securitization became a universally accepted financial instrument.