What is Securitization?

What is Securitization?

Securitization is to turn an asset which would otherwise not be a liquid, tradable security, into one.

Simply put, securitization turns assets into securities.

The most common example when discussing securitization is mortgage-backed securities, in which the cash flow of interest and principal payments on mortgage loans has been pooled, cut up, and distributed for sale in the form of marketable securities which can be held by an everyday investor. The bank or institution who sold the mortgage-backed securities receives cash which they can loan out to more home-buyers.

As far as the first mortgage goes, they no longer have any cash at stake, and they have passed the default risk off to the investors who bought the mortgage-backed securities. This can cause a problem when many lenders are competing to make loans to individuals who may not be financially stable, and then the lenders pass off that risk to third party investors.

Securitization refers most often to situations like this where an illiquid asset is made liquid, with the help of financial engineering. Other assets such as credit card debt, college loans, and car loans can also be securitized and are referred to as Asset-Backed Securities or Collateralized Debt Obligations (CDOs).

Ownership interest in a company is securitized and called stock.  

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