ECON 295 Lecture Notes - Lecture 10: Securitization, Financial Institution, Capital Adequacy Ratio
27 May 2016
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Part 1: traditional residential mortgages ( originate to own") Bank finds and evaluates potential borrowers, lends money to acceptable borrowers and keeps mortgages as an asset. Bank"s collateral for this loan is the market value of the home-and bank takes risk if borrower defaults: specialization in mortgage lending ( originate to distribute") Bank creates mortgage and sells it to another financial institution. Bank uses money from this sale to fund more mortgages, which it also sells (etc. )- no collateral but no risk! (passed on all risk to next financial institution) Result: specialist financial institution build huge stocks of mortgage asset: the rise of securitization of mortgage assets. The specialist financial institution can keep and manage a large portfolio of risky assets, or. Create lower-risk securities by repackaging" small bits of many of the higher-risk securities. (less risk=less return, people willing to pay more for securities with less risk, sell at higher prices)
