The Economics of Securitization: Evidence from the European Markets

Securitization is the process whereby financial assets are pooled together, with their cash flows, and sold to a specially created third party that has borrowed money to finance the purchase. The borrowed funds are raised through the sale of securities, in the form of debt instruments, into the market. Securitization is thus a technique used to transform illiquid assets into securities. Securitization creates value by increasing liquidity and funding, reducing the cost of funding, allowing originators to reach a funding sources diversification, improving originators’ risk management, increasing the segmentation between the origination and investment functions, and allowing originators to benefit from regulatory (and/or tax) arbitrage and to improve key financial ratios. Although the economic advantages, securitization also has problems, especially when used inappropriately. Considering the important role played by securitization in the development and propagation of the 2007/2008 financial crisis, the most commonly referred problems of securitization are complexity, off-balance sheet treatment, asymmetric information problems, agency problems, and higher transaction costs. Besides describing the economic motivations and problems of securitization, this paper provides details on asset securitization characteristics and players, presents the recent trends of securitization markets, describes the role played by securitization in the 2007/2008 financial crisis, and provides some statistics of asset securitization activity in Western Europe between 2000 and 2013.