A Primer on the Role of Securitization in the Credit Market Crisis of 2007

Abstract

In this paper I review the role of securitization in the credit markets and in particular the possible contribution of securitization to the credit crisis of 2007-2008. Based on this review I make the following observations: (i) over the last three decades the originate-to-distribute via securitization model has come to dominate the U.S. credit markets; (ii) the originate-to-distribute model has many possible advantages but brings with it a potentially fatal principal agent problem in the credit screening process; (iii) the growing complexity of the securitization process has given rise to a for lemons problem that may well have contributed to the collapse of the market for securitized issues; and (v) the collapse of the mortgage backed securities market resulted in the use of distress prices by financial institutions to mark-to-market their portfolios and this may well have contributed to the panic that resulted in the failure of the affected financial institutions.