Oversecuritization

Oversecuritization describes a pattern in securitization markets in which risk is redistributed through securitized products to an extent that may exceed the informational content and economic rationale of the underlying assets. It often arises when market participants securitize more assets than needed for funding or construct securities with multiple layers of tranches, credit enhancements, and interlinked vehicles. The result can be a perceived reduction in risk and an increase in funding liquidity for originators, even as investors face complex, opaque exposures.

Common techniques include large pools of loans or assets being securitized, the creation of senior and subordinated tranches, and the use of synthetic securitization, where risk is transferred via credit derivatives rather than actual asset transfers. Re-securitization, such as CDOs of CDOs, further compounds complexity by layering one securitized product atop another. These structures can distribute losses but also diffuse and obscure the correlation of risk across asset pools, making losses harder to assess during stress.

Critics argue that oversecuritization encourages lax underwriting, risk shifting off balance sheet, and ratings-driven incentives that misprice risk. It can amplify leverage and systemic interconnections, contributing to market volatility when asset performance deteriorates. In response, regulators have introduced retention requirements, enhanced disclosure, and stress-testing measures intended to curb excessive layering and improve alignment of interests between originators, sponsors, and investors. Today, oversecuritization is viewed with caution: securitization remains a useful funding tool, but aggressive layering and opaque structures are generally regarded as risks to financial stability.