Securitization: Bundling Up Loans for Investors Worked Well Until It Didn't

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1970 Ginnie Mae bundles mortgages together into Pool No. 1 and sells shares of it to investors.

The idea of bundling up loans and selling them to investors was supposed to make credit cheaper and less risky. Lenders could offload debts into the private market, freeing up capital to fund new loans. Meanwhile, investors would get payments from thousands of borrowers, spreading the risk.

It worked well for decades. In 1970, Ginnie Mae Pool No. 1 laid the groundwork for bundling mortgages. Fifteen years later, investors for the first time could own “slices” of other kinds of loans, starting with computer leases. Wall Street eventually found ways to pool all kinds of expected payments—loans to buy a used SUV or attend culinary school, TV rights for Gladiator or Shrek, royalties for drug patents and David Bowie’s songs, and franchise fees for Carl’s Jr. and Hooters.

But nothing drove the market, and the economy, more than mortgages. Securitization made credit cheaper and easier to gain access to—which also made it easier for consumers to load up on more and more debt. “I frequently think we did a very bad job in an honest attempt to do good,” mortgage bond pioneer Lewis Ranieri told Bloomberg News in 1999.

In the new millennium, securitization took on a life of its own. Issuance of asset-backed securities grew from less than $540 billion in 2000 to a peak of more than $2.4 trillion in 2006. The securities themselves were bundled up and sliced into pieces yet again—into collateralized debt obligations, creating one more layer between borrowers and the investors who bore the risk. As investors clamored for higher returns, lenders offered ever more exotic loans with hasty underwriting. America fell too deep in debt, the bubble burst, and the Great Recession began.

New rules passed after the financial crisis aim to force lenders who sell the loans to have some stake in how they perform in the future. The regulations haven’t all been enacted, leaving it uncertain whether the securitization markets can be trusted to flourish safely.

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