Question

Throughout the Great Recession, there was talk of securitization and terms like CMO's, CDO's and CLO's (financial instruments created through a process of securitization) were heavily used. Discuss the good and bad aspects of securitization. Is it something we should do away with or does it have a place in modern financial markets? Use Paddy Hirsch as a reference! Thank you!

Answer 1

Securitisation is the process of converting assets into securities which can be traded on platforms like stock exchanges.

There are both benefits and harms of such a process.

The advantages are:

1) Liquidity : It created liquidity by making the assets tradable. for eg. we can securitise a long term debt and receive money in the current itself.

2) Increase in economic activity: More trading means more value generation for the economy as people will invest more and save less.

3) Help meet need of different investors : investors with different need of investment options can invest in wide varieties of options created by securitisation.

Cons:

1) Risk of depression: since the investment is layered into further many layers by secutitisation process, it can lead to huge market downfall if the original underlying asset falters. For eg. if a debt is converted into securities in many steps and if ultimatlely the debtor does not pay off the debt, then all the investors will suffer as the value of all the securities will be affected.

2) difficult to understand: the process is not easily understood by all the investors due to its complicacy.

Hence, we can say that it is important to have such process for the economy to grow but should be used very cautiously and there should be some government intervention and check so that they do not harm the economy.