Yesterday, I was explaining to my students that the word, securities, had become an oxymoron. (I am a reality based instructor.) Ironically, within 24 hours, I run into this article which says that the problem of securities being a highly speculative investment has abated somewhat. If the numbers are accurate, things have improved.

From The Fiscal Times (from an article by Zachary A Goldfarb) –

For nearly two decades before the financial crisis erupted in 2007, the securitization market allowed Wall Street to manufacture all manner of financial products. The most basic of these were bundles of home, auto and credit card loans that were turned into single investments that firms and countries worldwide could buy.

But then things got more complicated. Wall Street found ways to allow investors to speculate on Hollywood films, patents, lawsuits, airplane sales, and fast food revenues. The most infamous financial engineering, of course, involved the creation of seemingly high-quality investments that were in fact backed by high-risk home loans, extended to people with weak finances.

These subprime mortgage-backed securities helped doom the financial system starting in 2007, and the securitization market has been working to make its way back ever since. Although it has had some success, particularly in auto and student loans, participants at the ASF conference here said that they expect financial engineering to play a far smaller role in the markets for years to come.

“Banks will be utilizing securitization less in the future than they have in the past,” said Bianca Russo, managing director at J.P. Morgan Chase.

In total, there was $145.3 billion in securitizations in 2010, compared with $875.5 billion in 2005, and far below the number even a decade ago, according to industry newsletter Asset-Backed Alert.

Every time I explain what a security based on home loans looks like broken down into its parts, my students are amazed that anyone would buy them. But then I show them what the paperwork looked like to an investor. If you can divide the home loans between, prime and sub-prime, only then can you see how much trouble you are in. But the poor investor can only see a list of smaller investments perhaps of thousands of mortgages which for accurate knowledge need to be researched individually. The investor would have felt that they needed no such investigation because the security was  rated as triple A by an international ratings corporation like Moody’s. Investment firms like Goldman Sachs are not required by law to disclose risks with an investment they are selling. So, the investor was swathed in assurances that he was making a good investment when for all intents and purposes he was driving blind in a snowstorm. And in 2007, they hit the wall.

James Pilant