“CNBC – Sub-prime mortgages make a comeback—with a new name and soaring demand“
The wheel. The printing press. Sub-prime mortgage securitization.
The three greatest innovations in human history. Prior to the wheel, ancient man was destined to live a relatively stationary life. There was no ability to explore, hunt and migrate beyond the area that you could walk and carry your belongings. It resulted in tribes and solitude. Before Gutenberg, Western Civilization was mired in a medieval rut. People relied on scribes to replicate texts, making it almost impossible to spread new ideas en masse. Once the printing press entered the scene, the great enlightenment took off, leading to what we know as The Renaissance. Preceding the boom in sub-prime mortgage securitization, banks were relegated to making markets in the infinitely boring world of agency paper and prime, private label mortgages. It was almost impossible to make a decent buck, the typical structured finance banker usually only had two or three different pairs of Gucci 53’s – these were trying times, indeed. Once Angelo Mozilo started slingin’ subprime credit around the West Coast, though, things would never be the same. Bankers were closing deals and collecting fees hand over fist. Working at a ratings agency wasn’t nearly as bad (this pertains to working in the structured finance group, can’t say the same for corporates or munis). There were even new industries growing as bankers left their analysts behind to set up their own shop as CDO managers. This was the height of human ingenuity and it changed the world (while making a handful of people a bunch of money).
Look – I’m not here to praise what happened with the sub-prime mortgage boom, but I’m not here to relentlessly bash it either, no matter how snide and sarcastic the previous paragraph was. There is no doubt that the boom in sub-prime credit and the securitization machine that fueled it played a large role in the financial crisis (side note: I wonder when we’ll stop calling it THE financial crisis, like there haven’t been many before and will be many after). But there were also other causes as well, like the rewrite of the Community Reinvestment Act in 1995, which incentivized banks to extend mortgage credit to communities with outsized populations of “credit deprived” citizens in order to stimulate local economies that needed it (good!). That also meant that banks needed to throw their standard underwriting practices out the window and lend money to people who were previously deemed unworthy of credit in the first place (bad!). One could also look to Alan Greenspan’s tenure at The Fed, where he opened the monetary spigots and took, what some believe to be, too much of a laissez faire attitude toward regulating the exploding sub-prime mortgage markets.
Securitization (sub-prime included) is a much-maligned, but widely misunderstood capital markets mechanism that does have great benefits. It plays a very important role in a modern, credit-based economy that takes place largely behind the scenes. The purpose of securitization is to assist banks in financing the borrowing activities of a large pool of individuals or corporations through the use of third party (investor) capital. The beauty is, you can securitize almost anything: mortgages, credit card balnces, aircraft leases, capital assets, you name it. Hell, even David Bowie securitized the future profits from his catalog. In a nutshell, banks are able to extend credit to borrowers, structure the future interest/principal cash flows from the borrowers into securities and sell those to investors. This allows the bank to move the debt off its own balance sheet, freeing up the capital to continue lending into the economy. This is a great thing if done in a proper way and I doubt everyone really understands how much of an impact it has on their daily life (including allowing us to live and spend the way we do).
Sure, things got out of hand last time and it really did blow up in our faces. But when I see alarmist headlines like this out of CNBC it makes me shake my head, because lending to people who need it is a good thing and all that does is perpetuate the belief that these funding mechanisms are inherently detrimental to society. Sub-prime mortgages and securitization didn’t cause the financial crisis, people did (and odds are, they’ll do it again with something else).