securitizationi

Securitization is a financial technique that pools relatively liquid or illiquid assets—such as residential mortgages, auto loans, or credit card receivables—and issues securities backed by the cash flows from those assets. A special purpose vehicle (SPV) or trust is created to hold the assets and to issue the securities, helping to isolate the assets from the originator's other obligations. The securities are designed in tranches with different priorities for payment and levels of credit enhancement, allowing investors to choose risk-return profiles.

In a typical securitization, the originator transfers assets to the SPV in a true sale, and the SPV issues senior and subordinated notes to investors. Cash flows from the pool pass through to investors according to a waterfall structure. Credit enhancements, such as overcollateralization, reserve accounts, and external guarantees, improve senior tranche ratings and reduce default risk.

Instruments include mortgage-backed securities (MBS), asset-backed securities (ABS), collateralized debt obligations (CDOs), and synthetic securitizations that use credit derivatives rather than transferring assets. Securitization can be used to diversify funding sources and transfer risk from lenders to capital markets.

History and regulation: Securitization expanded in the United States from the 1970s onward, with mortgage securitization playing a central role in the growth of the market. It contributed to the financial crisis of 2007–2008, after which reforms strengthened disclosure, risk retention, and transparency. Regulatory developments include measures to increase due diligence and capital quality, such as risk-retention requirements and standardized labeling for certain securitizations.

Benefits and risks: Securitization can provide liquidity for originators, diversify funding, and transfer risk, but it also introduces model, operational, and complexity risks and can create systemic linkages. Regulation seeks to improve transparency, accountability, and prudent risk management in securitization activities.