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Securitization and structured products. Securitization—oft en pejoratively
described as the “originate to distribute process”—has also been blamed for the
fi nancial crisis. But securitization is only a means of fi nancing. If securitization was
a cause of the fi nancial crisis, so was lending. Are we then to condemn lending?
For decades, without serious incident, securitization has been used to fi nance car
loans, credit card loans and jumbo mortgages that were not eligible for acquisition
by Fannie Mae and Freddie Mac. Th e problem was not securitization itself, it was
the weak and high risk loans that securitization fi nanced. Under the category of
securitization, it is necessary to mention the role of collateralized debt obligations,
known as CDOs. Th ese instruments were “toxic assets” because they were ultimately
backed by the subprime mortgages that began to default in huge numbers when the
bubble defl ated, and it was diffi cult to determine where those losses would ultimately
settle. CDOs, accordingly, for all their dramatic content, were just another example
of the way in which subprime and other high risk loans were distributed throughout
the world’s fi nancial system. Th e question still remains why so many weak loans
were created, not why a system that securitized good assets could also securitize
bad ones.
Credit default swaps and other derivatives. Despite a diligent search, the FCIC
never uncovered evidence that unregulated derivatives, and particularly credit
default swaps (CDS), was a signifi cant contributor to the fi nancial crisis through
“interconnections”. Th e only company known to have failed because of its CDS
obligations was AIG, and that fi rm appears to have been an outlier. Blaming CDS
for the fi nancial crisis because one company did not manage its risks properly is like
blaming lending generally when a bank fails. Like everything else, derivatives can
be misused, but there is no evidence that the “interconnections” among fi nancial
institutions alleged to have caused the crisis were signifi cantly enhanced by CDS
or derivatives generally. For example, Lehman Brothers was a major player in the
derivatives market, but the Commission found no indication that Lehman’s failure
to meet its CDS and other derivatives obligations caused signifi cant losses to any
other fi rm, including those that had written CDS on Lehman itself.
Predatory lending. Th e Commission’s report also blames predatory lending
for the large build-up of subprime and other high risk mortgages in the fi nancial
system. Th is might be a plausible explanation if there were evidence that predatory
lending was so widespread as to have produced the volume of high risk loans that
were actually originated. In predatory lending, unscrupulous lenders take advantage
of unwitting borrowers. Th is undoubtedly occurred, but it also appears that many
people who received high risk loans were predatory borrowers, or engaged in
mortgage fraud, because they took advantage of low mortgage underwriting
standards to benefi t from mortgages they knew they could not pay unless rising
housing prices enabled them to sell or refi nance. Th e Commission was never able
to shed any light on the extent to which predatory lending occurred. Substantial
portions of the Commission majority’s report describe abusive activities by some
lenders and mortgage brokers, but without giving any indication of how many such
loans were originated. Further, the majority’s report fails to acknowledge that most
of the buyers for subprime loans were government agencies or private companies
complying with government aff ordable housing requirements.