Edited by Masahiro Kawai, David G. Mayes and Peter Morgan
Chapter 5: Securitized Products, Financial Regulation and Systemic Risk
Mariko Fujii 5.1 INTRODUCTION It is widely believed that the practice of securitization was one of the causes of the 2007–2009 financial crisis.1 Krugman (2007) summarizes the issue as follows: in the later stages of the great 2000–2005 housing boom, banks were making a lot of dubious loans . . . For a while, the risks of subprime loans were masked by the housing bubble itself . . . Yet the banks making the loans weren’t stupid: they passed the buck to other people. Subprime mortgages and other risky loans were securitized. However, it turns out that the financial institutions that held a large amount of subprime-related securitized products recorded tremendous losses. As discussed by Diamond and Rajan (2009), it is surprising that these institutions held on to so many mortgage-backed securities (MBSs) in their portfolios, given that the originators would have sensed the deterioration of the underlying quality of mortgages. The financial statements of some banks revealed large holdings of these ‘toxic’ securitized products. According to Citigroup financial statements (Citigroup 2007, 2008), at the end of September 2007, the total amount of their subprime-related direct exposures in securities and banking, which comprised net collateralized debt obligation (CDO) ‘super-senior’ exposures and gross lending and structuring exposures, amounted to United States (US)$54.6 billion. This amount decreased to US$19.6 billion one year later; at the end of March 2009, there was still US$10.2 billion in these investments. Although Citigroup claimed that much of its holdings were in super-senior tranches, its performance was far...
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