Narrated by David Harper, these excellent videos from Bionic Turtle illustrate the concepts and principles behind asset-backed securities (ABS) and securitization. ABS include Mortgaged-backed securities, Collateralized Debt Obligations, and many others–and are the prominent “star” of the recent financial crisis.
Although the videos are technical, they are presented in lay-man language enough for everyone to learn the basic principles behind securitization and perhaps help shed insights on how and why the financial crisis started, and can be averted in the future.
What Is Securitization?
Key Players In Securitization
Securitization Using Special Purpose Vehicles (SPVs) — Corporations vs. Trust
ABCs of CDOs (Collateralized Debt Obligations)
Subordination and Overcollateralization
Credit Enhancements In Securitization
[...] firsthand experience in a commercial bank’s risk and asset division, is witness to the financial wizardry the modern financial system employs to build the mountain of debt on which our capitalist societies [...]
mtm, according to above, the first to absorb the payment default is the subordinate, then the mezanine, and the big investors are almost untouched and unaffected. In real bank scenario, what are the products that represent each category? (Example: trust fund=upper, money market= mezanine, time dep=lowest) Isn’t it most bank products have fixed rates anyway? Do the videos talk about commercial banks in general?
–Layman trying to make sense of the info above for practical life application..Pls. enlighten..
Yes. Among the purposes of securitization is not only to divide risks into chunks that can easily be distributed, but also to segment risks into various “tiers” that can apply to different risk appetites.
The downside is that in practice, risks are all correllated anyway–so a default in the lower tiers will most likely affect the senior notes eventually. So even if the senior tiers have a AAA rating, if its in the same pool as crappy assets, you’ve only disguised the crap as AAA through securitization.
The most common securitized assets are debt securities–like bonds. A lot of corp bonds were issued locally lately, and they were called “tier-2″ or “subordinated” notes. That means should there be a cash shortage, the company would pay them last amongst creditors.
The coupon rates of debt securities are fixed–but the coupon varies depending on the tier. The most senior notes could go for the lowest yield, say 4%, but are rated AAA, while the subordinated notes could have a coupon of 6%, but rated only A+. In reality, the underlying asset behind the security should be earning more than 6%, but more cashflow is held as buffer for the senior notes to cushion them in case of a default. For the subordinated tier, more cash is paid out, but if there is a default, there is little or no cash buffer so the investor feels the default immediately.
The important thing to remember about securitization is to understand the underlying asset behind the security, regardless of the tiering and rating. Just in the last half decade many investors were taken simply by the AAA rating, but didn’t check if the asset pool had defects or high risk assets. So when the inevitable happened, they didn’t react fast enough.