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Copyright © 2010 Thunderbird School of Global Management. All rights reserved. This case was prepared by Drs. F. John Mathis and Frank Tuzzolino, Professors of Global Finance at Thunderbird, and Mr. Venkat Ramaswamy, Managing Director of Srinidhi Capital Management in India, and a practicing expert in structured finance for the purpose of classroom discussion only, and not to indicate either effective or ineffective management.

F. John MathisFrank TuzzolinoVenkat Ramaswamy

Global Financial Crises and the Future of Securitization

BackgroundRajani Ramaseshan, an outstanding graduate of an MBA program at a major U.S. university, was a global finance specialist. Before he graduated, Rajani had spent a summer on an internship at Citibank (now called Citi) in their asset-backed securities area learning about the structuring of mortgage-backed securities. Rajani’s career goal was to secure a position structuring securitized products at a major global bank’s capital markets area or at an investment bank.1 Rajani took every graduate course he could on structured finance, with a focus on securi-tization. He had studied global capital and equity markets, and learned about the new instruments impacting both corporate treasury and global investment management. He had also studied global portfolio management to better understand the changing trends in what investors wanted and why.

He landed a position with one of the top structured finance shops on Wall Street after graduation. In 2003, Rajani was recruited by HSBC Americas to work in New York as an associate and, after a two-year rotation pro-gram, he joined the global corporate lending division covering major multinational corporations headquartered on the east coast of the United States.

In his new position, Rajani was pitching ways for major corporations to benefit from using securitized financial instruments to better market their products globally, gain market share, and grow their corporations competitively. Securitization reduced companies’ cost of funding, gave them immediate cash for their sales, pro-vided some tax benefits, and reduced their receivables. Within two years, Rajani was promoted to vice president, and his career was accelerating rapidly. He honed his skills in marketing securitized products in support of the strong growth in corporate profits driven by the continuing global economic expansion. All seemed well.

Then, in late January 2007, the major financial newspapers began reporting on problems in the U.S. housing industry and fears that the four-year growth bubble in housing prices might burst. Mortgage-backed securities were a major segment of the structured finance market, and there was growing concern on Wall Street, at the Federal Reserve, and the U.S. Treasury of a possible shock to this part of the financial market. Rajani had developed a close working relationship with the head of the structured finance area at HSBC, and both were increasingly concerned about the viability of subprime mortgages in the mortgage-backed securities market. As Rajani called his colleagues at Citi and JPMorgan/Chase on several occasions over the next couple of months, he learned that they also had growing anxiety about what was happening in this massive and still rapidly expanding segment of the capital market.

By June 2007, financial markets were in a state of turmoil, and the picture was deteriorating rapidly day by day. Rajani’s corporate clients, who had used securitized products so effectively to boost sales and profits, were

1 Securitization involves the pooling of assets and the subsequent sale to investors of claims on the cash flows backed by these asset pools.

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calling regularly, and Rajani did not know what to tell them other than that the structured finance market was not functioning well because of the increasing subprime defaults. Neither Rajani nor anyone else knew what would happen next. Until the crisis was resolved, the structured finance market would likely remain closed to even the best corporate transactions. But no one seemed to know how long that would take. Rajani was not sure what his corporate customers would do in the meantime. Furthermore, Rajani worried about the longer-term viability of the structured finance market. What had gone wrong, and could it be corrected?

A more fundamental concern to the bank and Rajani’s clients was the use of securitized products in the future. Would government regulations make it so costly that they would no longer be used? See Exhibit 1 for recent activity as reported by IMF.2

Rajani was assigned by his direct report to allocate a couple of days to researching recent financial crises in order to acquire a deeper understanding of the factors that had caused the 2007-2009 crisis and how past crises had been resolved. Thereafter, Raja was requested to prepare an analysis and report on the future viability of securitization. He identified three major recent crises prior to the current one: the Asian foreign debt crisis in mid-1997; the collapse of Long Term Capital Management in 1998-2000; and the technology equity bubble in 2000.3

What is Structured Finance?Structured finance is a process of changing the structure of cash flows and distributing default risk by aggregat-ing debt instruments in a pool. The pool is then divided into portfolio tranches (differing amounts of risk in a deal), and then the tranches are securitized and issued as new securities backed by various forms of credit and liquidity enhancements. Structured finance began to emerge in the 1970s building on an old practice of dis-

2 See International Monetary Fund, Global Financial Stability Report: Sovereigns, Funding, and Systemic Liquidity, October 2010.3 Rajani did a Google search and found summary briefs of the crises in Wikipedia and Investipedia, which have been further condensed in this case to provide a summary perspective on the crises and their causes. Nicholas Dunbar, Inventing Money, Wiley, 2000, is also an excellent reference source for more detailed insights.

Exhibit 1. Dramatic Decline in Structured Product Market

CDO = collateralized debt obligation; CDO2 = collateralized debt obligation-squared and CDOs backed by asset-backed securities (ABS) and residential mortgage-backed securities (RMBS).

Source: IMF staff estimates based on data from JPMorgan Chase & Co.; Board of Governors of the Federal Reserve System; and Inside Mortgage Finance.

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counting, factoring, and forfeiting of receivables and trade finance. It was modified following the global foreign debt crisis in the mid-1980s when securitization was added as a way to convert debt into equity. Then, in the 1990s, structured finance evolved further by incorporating financial engineering to structure products to fit the risk and cash flow preferences of investors. Complex asset diversification structures emerged, including a variety of credit and liquidity enhancement techniques. In addition, Credit Default Swaps (CDS) were incorporated to customize the end security to suit the cash flow needs and risk appetite of an expanding investor base. In 2007, more than $1 trillion in structured credit was issued and, at its peak, the estimated outstanding amount of the market exceeded $4 trillion in the U.S. and $1 trillion in Europe.

During the 2000s, the focus of structuring products shifted to volume and achieving economies of scale in order to lower the overall cost of originating loans. This drove the need to expand the sources of cash flow to include more types of assets beyond mortgages, autos, and credit cards. It also promoted the development of synthetic products. What emerged was a variety of very complex financial instruments employing sophisticated credit risk models to determine how to structure the pooled assets to achieve the desired risk profile and cash flow to the investors. In what is often called the Cash Flow Waterfall mechanism (because of its cascading effect between asset classes), if losses begin to rise, the flow through the tranches threatens the lower rated equity and mezzanine tranches first. For example, normally in a Collateralized Debt Obligation (CDO) structure, if 7%-8% losses occur then securities below a Ba rating are wiped out; 13%-15% losses wipe out all Baa and below-rated securities, and 11%-14% losses on subprime mortgage-backed securities wipe out everything from single A tranches down.

The Role of Structured Finance in Financial CrisesFour significant global financial crises have occurred since 1997, during which time the widespread use and de-velopment of structured products expanded rapidly. What follows is a brief review of the causes, what happened, the role of securitization if any, and what was done to end the crises.

Asian Financial Crisis—The Asian financial crisis hit most of Asia in 1997 and raised concerns that it would become a global crisis. The crisis was primarily the result of excessive foreign debt levels and rising foreign debt service payments which spilled into the domestic economy with excess leverage ratios supporting real estate speculation. The turning point was triggered in Thailand with the collapse of the Thai baht as the government depegged its currency from the U.S. dollar. The collapse of the Thai currency was driven by the accumulation of foreign debt with short maturities which could not be serviced. Contagion carried the crisis to Southeast Asia and Japan, resulting in depreciating currencies, devalued equity markets, and falling asset prices. The International Monetary Fund (IMF) intervened with a $40 billion currency stabilization policy for South Korea, Thailand, and Indonesia. It came with conditions, of course. The IMF’s restrictive economic policy required a reduction in government spending in order to reduce deficits, an increase in interest rates, and encouraged governments to allow bank failures. This caused a worsening of the crisis as governments failed to service their foreign debts. After a period of significant financial, economic and political restructuring, and major high-growth sector bankruptcies, the economies gradually recovered after 1999 from the serious growth disruption, but the coun-tries involved offered strong criticism of IMF policies. Their governments began to follow a policy of building international reserves to avoid any future need to have to rely on IMF support. This crisis had nothing to do with structured finance.

Long Term Capital Management (LTCM)—LTCM was founded in 1994 by John Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers.4 The members of the Board of Directors of LTCM included Myron Scholes and Robert C. Merton, who jointly received the 1997 Nobel Prize in Economics. Meriwether chose to start a hedge fund to avoid the financial regulation imposed on more traditional invest-ment vehicles. LTCM was initially very successful, achieving annualized net returns less management fees of more than 40%.

4 John Meriwether headed Salomon Brothers’ bond trading desk until he was forced to resign in 1991 when his top bond trader, Paul Mozer, admitted to falsifying bids on U.S. Treasury auctions. Though Meriwether was not directly implicated, calls for his ouster rose within the company, and he resigned before he was to be let go. See Nicholas Dunbar, Inventing Money: The Story of Long-Term Capital Management and the Legends Behind It, New York: Wiley, 2000.

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The fund’s operation was designed to have extremely low overhead; trades were conducted through a partnership with Bear Stearns, and client relations were handled by Merrill Lynch.5 The company used complex mathematical models to take advantage of fixed income arbitrage deals (termed convergence trades), usually with U.S., Japanese, and European government bonds. Government bonds are a “fixed-term debt obligation,” meaning that they will pay a fixed amount at a specified time in the future.6 For instance, differences in the bonds’ present value are minimal, so, according to economic theory, any difference in price will be eliminated by arbitrage. To note, price differences between a 30-year Treasury bond and a 29-and-three-quarter-year-old Treasury bond should be minimal—both will see a fixed payment roughly 30 years in the future. However, small discrepancies arose between the two bond types because of a difference in liquidity.7 By essentially buying the cheaper 29-and-three-quarter-year-old bond and shorting the more expensive, but more liquid, 30-year bond just issued by the U.S. Treasury, it would be possible to make a profit, as the difference in the value of the bonds narrowed when a new bond was issued.

As LTCM’s capital base grew, its managers felt pressed to invest that capital, but had run out of good bond-arbitrage bets which led LTCM to undertake more aggressive trading strategies. By 1998, LTCM had extremely large positions in areas such as merger arbitrage and S&P 500 options (net short long-term S&P volatility). LTCM had become a major supplier of S&P 500 Vega, which had been in demand by companies seeking to essentially insure equities against future declines.8 Because these differences in value were minute—especially for the convergence trades—the fund needed to take highly leveraged positions to make a significant profit.

At the beginning of the year, the firm had equity of $4.72 billion, and had borrowed more than $124.5 billion with assets of around $129 billion, for a debt-to-equity ratio of about 25 to 1. It had off-balance sheet derivative positions with a notional value of approximately $1.25 trillion, most of which were in interest rate derivatives such as interest rate swaps. The fund also invested in other derivatives such as equity options.

Factors giving rise to the downfall of the fund were rooted in the 1997 East Asian financial crisis, which had a role in precipitating the subsequent Russian financial crisis later in 1998. In May and June 1998 returns from LTCM had declined to -6.42% and -10.14% respectively, reducing their capital by $461 million. This was further aggravated by the exit of Salomon Brothers from the arbitrage business in July 1998. Such losses were accentuated because of the Russian financial crisis in August and September 1998, when the Russian government defaulted on its government bonds. Panicked investors sold Japanese and European bonds to buy U.S. Treasury bonds. The profits that were supposed to occur as the value of these bonds converged became huge losses as the value of the bonds diverged. By the end of August, the fund had lost $1.85 billion in capital.

After LTCM failed to raise more money on its own, it became clear that it was running out of alternatives. In September, Goldman Sachs, AIG, and Berkshire Hathaway offered to buy out the fund’s partners for $250 million, to inject $3.75 billion, and to operate LTCM within Goldman’s own trading division. The low offer was not accepted.9 With no other offers available, the Federal Reserve Bank of New York organized a bailout of $3.6 billion from the major creditors to avoid a wider collapse in the financial markets.10

The contributions from the various institutions were as follows:11 $300 million from each of the following—Bankers Trust, Barclays, Chase, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, Merrill Lynch, JP-Morgan, Morgan Stanley, Salomon Smith Barney, UBS; $125 million from Société Générale; and $100 million from Lehman Brothers and Paribas. Bear Stearns declined to participate. In return, the participating banks got a 90% share in the fund and a promise that a supervisory board would be established. LTCM’s partners received a 10% stake, still worth about $400 million, but this money was completely consumed by their debts. The partners once had $1.9 billion of their own money invested in LTCM, all of which was wiped out.12

5 Both Bear Stearns and Merrill Lynch would have to be taken over by other banks to prevent their collapse in the subprime loan crisis in 2007-2009.6 Dunbar, p. 80.7 Ibid., p. 98.8 Roger Lowenstein, When Genius Failed: The Rise and Fall of Long-Term Capital Management, Random House, 2000, pp. 124-125.9 Ibid., pp. 203-204.10 Frank Partnoy, Infectious Greed: How Deceit and Risk Corrupted the Financial Markets, Macmillan, 2003, p. 261. 11 Wall Street Journal, September, 25, 1998; and, on the same day, bloomberg.com:exclusive news report.12 Lowenstein, pp. 207-208.

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The fear was that there would be a chain reaction as the company liquidated its securities to cover its debt, leading to a drop in prices, which would force other companies to liquidate their own debt, creating a cycle. Some industry officials said that the Federal Reserve Bank of New York’s involvement in the rescue, however benign, would encourage large financial institutions to assume more risk, in the belief that the Federal Reserve would intervene on their behalf in the event of trouble. The Federal Reserve Bank of New York actions raised concerns among some market observers that it could create moral hazard.13

In all, LTCM lost about $4.6 billion in less than four months in the market turmoil that preceded Russia’s default on its debt, because of its highly leveraged investments in high-risk instruments and in Russia. LTCM went out of business in early 2000. What did these extremely bright experts miss, or was this an example of misdirected greed? This crisis had nothing to do with structured products.

The Technology Equity Price Bubble—The tech, or dot-com, bubble occurred during 1998-2000 and peaked on March 10, 2000, with the NASDAQ hitting an all-time high of 5,132.52. Equity markets in industrialized nations experienced a rapid price rise from growth in the “new” Internet sector and Web technology-related fields in the 1990s.

A combination of rapidly increasing stock prices, market confidence that the companies would turn future profits, individual speculation in stocks, and widely available venture capital funding created an environment in which many investors were willing to overlook traditional performance metrics such as price-to-earnings ratio in favor of unsubstantiated confidence in sales of technological advancements.

Venture capitalists saw sharp rises in stock valuations of dot-com companies. Low interest rates in 1998-99 made it easier for dot-com borrowers to increase the amount of their start-up capital. Although a number of these new entrepreneurs had realistic plans and management ability, many more of them lacked the required business skills, but were able to sell their ideas to anxious investors with ready cash to invest.

A basic dot-com company’s business model relied on operating at a sustained net loss to build potential market share. These companies expected that they could build enough brand awareness to charge profitable rates for their services later. During the loss period, the companies relied on venture capital, and especially initial public offerings of stock, to pay their expenses. The novelty of these tech stocks, together with the difficulty of valuing these companies, sent many stocks to unrealistic heights, making the dot-com owners rich on paper in a short period of time.

Then in 1999 and early 2000, the U.S. Federal Reserve increased interest rates repeatedly, and the economy began to slow. The dot-com bubble burst in March, 2000, when the technology-heavy NASDAQ composite index peaked at more than double its value just a year before. The herd effect of investors, funds, and institutions liqui-dating positions resulted in the index falling by nearly 9%, to 4,580, in one week. In addition, the bursting of the tech bubble also may have been aggravated by the passing of the Y2K scare in January 2000 and the poor results of Internet retailers released in March following the 1999 Christmas season. By 2001, the bubble was deflating at full speed, and a majority of the dot-coms stopped trading after burning through their venture capital, with many having never made a profit. Once again, this crisis was not the result of the use of structured products.

The 2007-2009 Financial Crisis Hits—Since the 1929 stock market crash, which led to the Great Depres-sion, the world had not experienced such a serious financial market breakdown as that which hit in 2007. High unemployment and lack of growth devastated global financial and economic markets.14 The crisis started in the United States with defaults on subprime loans triggered by the Fed raising interest rates and tightening credit, resulting in a bursting of the housing price bubble. This was followed by the upward adjustment of low teaser interest rates on adjustable rate mortgage loans to subprime borrowers who were not able to pay the higher inter-est rates. Although subprime mortgages accounted for less than 20% of total mortgages in the U.S., delinquen-cies, defaults, and foreclosures spread rapidly. The decline in home prices by as much as 30% to 50% in some 13 General Accounting Office, GAO/GGD-00-67R Questions Concerning LTCM and Our Responses, February 23, 2000.14 The crisis was so severe that several basic tenets of finance were violated by the government in order to resolve it. For example, risk-rating rules were violated regarding the security of corporate debt as the first claim on corporate assets in the event of defaults, and the concept of true sale was violated for securitization.

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locations (California, Florida, Nevada, and Arizona), accompanied by a sharp economic recession and rising unemployment, amplified the spread of the defaults and foreclosures beyond subprime loans.

Defaults increased on almost all mortgage loans, and then spread to commercial real estate and consumer loans, especially credit card debt. At the same time, equity prices collapsed as investor recession fears rose, and they sought liquidity. As the economy rapidly slowed, credit card delinquencies jumped, followed by a sharp rise in commercial real estate defaults during 2009. Following four successive quarters of negative real GDP growth in 2009, unemployment hit 10% by year-end. What had started in the U.S. with subprime loans had now become a worldwide collapse in economic activity.

Exhibit 2 shows the seriousness of the housing price decline and adjustable interest rate mortgage problem which resulted in defaults and foreclosures, particularly among low-income homeowners—but the problem was not confined to this income class. The interest rate adjustment problem will continue until 2012 before the volume of adjustable rate mortgages falls sharply.

Exhibit 2. Large Amounts of Interest Rate Adjustable U.S. Mortgages Continue into 2012 (First reset in billions of U.S. dollars)

Source: Credit Suisse.

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Investigating the details of the failures associated with subprime loans revealed that there were a number of causes. The rapid growth that was experienced in the subprime segment of the mortgage market did not allow for the diligent training of new hires or the screening and verification of new employees for their prior experi-ence. Second, the lend-to-securitize high-volume model did not demand care, consistency, and due diligence in processing new borrowers. Third, mortgage originators convinced themselves—and lenders—that housing prices would continue to rise, creating positive equity for the borrower. Fourth, greed drove originators to focus on volume, not quality, resulting in fraud by some of the originators to meet their goals. Examples of bad prac-tices included no appraisal, no income verification, sometimes even no documentation, and loan-to-value ratios exceeding 100% of an undocumented value of the home.

In securitization, originated mortgages are sold to a structuring institution, usually a bank, which then divides the mortgages into tranches based on their structure, expected performance, location, conforming or nonconforming, and other criteria. The tranches are then officially rated by one of the rating agencies. The rating determines the amount of credit enhancement needed to elevate the securitized structure to a triple A (AAA) rating or other rating so that it can be sold to investors requiring that risk level. The agency’s rating of the tranche of mortgage cash flows determines the amount the bank must spend on credit enhancement or default insurance. So, there is little incentive for a bank to question the rating agency’s historic approach to setting the rating, even if the bank is aware that the mortgage loan may be at a higher risk of default going into the structur-ing process. Rating agencies, anxious for additional income, were not diligent in assigning ratings to match the lax loan conditions, and unquestioningly followed the guidance of the structurer in setting the tranche rating in order to generate more income.

Finally, in some cases, the banks involved in securitization invested in the super-senior tranche, which had Credit Default Swap (CDS) protection from any possible risk of loss from default. Because of the explosive volume of CDSs written by several major insurance companies, when defaults rose, the insurance providers of CDSs collapsed. In the case of American Insurance Group (AIG), the CDS exposure was so large that it had to be rescued by the U.S. government to prevent a possible collapse of the global financial system. Banks were also exposed directly, as noted below:

…because they warehouse assets to be subsequently restructured into CDOs and SIVs and may have to take (impaired) assets back on their balance sheets (into inventory) as funding dries up for their SIVs. Conduits also have credit lines from various banks established for such contingencies and, as these are drawn, banks are further drawn into loan exposure to troubled entities.15 There is also a concern that banks have lent to other groups such as hedge funds (in some cases, they are the bank’s own hedge funds) to invest in structured products in a levered way.16

In the case of hedge funds not owned by the banks, but that borrowed from prime brokers to fund their purchase of the high-yielding risky CDO tranches, this resulted in a further negative loss impact on major commercial and investment banks. Finally, some of these hedge fund investments had been done on margin. It is estimated that hedge funds owned almost half of the synthetic and cash CDOs (estimated at $1.4 trillion), followed by banks at 25% (estimated at $750 billion).17

Major commercial and investment banks involved in mortgage securitization sold structured products to investors to remove loans from their balance sheet. They were forced to take back these assets onto their balance sheet to protect their reputation and avoid loss of confidence in the bank. Thus, overnight, major banks found themselves short of capital and short of loan loss reserves to offset the jump in nonperforming loans. As these banks tried to borrow from each other in the overnight LIBOR market and from many other sources, liquidity disappeared and interest rates jumped as confidence in the banks vanished even among themselves.

Another reason that contributed to failure of major banks is mark-to-market accounting treatment of assets which undermined their liquidity. As demand for instruments decreased, financial institutions refused to sell these instruments, as the sale at a lower price would force a write-down of other securities, adding illiquidity to

15 Adrian Blundell-Wignall, “Structured Products: Implications for Financial Markets,” Financial Market Trends, OECP, Paris, Volume 2007/2, No. 93, p. 43.16 Ibid., p. 39.17 Ibid., pp. 39, 45.

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the market. Following the crisis outbreak, the FASB revised and set aside the mark-to-market requirement when markets are not actively trading the securities.18

The resulting global banking and insurance liquidity and, in some cases, solvency crises precipitated a breakdown of the global capital and credit markets. As a result, governments around the world took steps to inject funds to rescue these financial institutions from collapse. Several major U.S. banking institutions such as Bear Sterns, Lehman Brothers, Merrill Lynch, Countrywide, and Washington Mutual failed and were acquired into other financial institutions with government support. Most of the remaining major U.S. financial institutions—including the giants Citi and Bank of America—were forced to take government assistance, increase their capital, and build loan loss reserves, as were other banks and investment banks.

The Causes of the 2007-2009 Financial CrisisThe earlier crises that Rajani reviewed had two common major characteristics: excessive liquidity, and excessive leverage. The same causes appear to have precipitated the 2007-2009 crisis. Financial innovation is often the result of tax law changes, regulatory changes, excessive liquidity, and low interest rates, which all tend to sup-port rising leverage. In the case of the subprime loan crisis, Congress eased the financing requirements of Fanny Mae and Freddie Mac to expand home ownership to low-income families whose real incomes had fallen during the 1980s.19 There are benefits that resulted during the 2000s subprime securitization growth period, including expanded home ownership to lower income households, corporate restructuring that improved productivity, and risk transfer and dispersion to those that were better equipped to hold the risk.20 At the same time, securitization altered various aspects of risk analysis and management in credit extension as it spread risk to remote investors. Loan originators had less incentive to perform due diligence in evaluating borrowing quality, and repayment risk was transferred to someone else.21

Most financial market analysts identified three major factors that triggered the 2007-2009 financial crisis. First, shoddy and fraudulent practices by untrained and unregulated mortgage originators. This was supported by Congress easing the mortgage lending standards of Fannie Mae and Freddie Mac, which are large U.S. government-sponsored entities that purchased most conforming mortgages. Second, failure by the rating agen-cies to adequately rate the credit tranches that made up the special purpose vehicles. And third, failure of the banks that structured the products to adequately communicate and protect themselves and the investors from correlation and counterparty risk.

Focusing on specific developments in the U.S., there are two broad categories of mortgage originators. First, those that originate and retain the mortgage obligation on their books as part of their loan portfolio.22 Second, mortgage originators that originate and sell the mortgage obligation to an institution which then securitizes the mortgage-backed security to generate fee income, and subsequently sells the structure to a Special Purpose Vehicle (SPV)23 or Special Investment Vehicle (SIV).24

Mortgage originators that sell all they originate are generally unregulated and not involved in credit risk analysis. Instead, they normally originate to meet the specific terms and conditions of the securitization pool or

18 John Heaton, Deborah Lucas, and Robert McDonald, “Is Mark-to-Market Accounting Destabilizing? Analysis and Implications for Policy,” Working Paper, University of Chicago and Northwestern University, 2008.19 Raghuram G. Rajan, Fault Lines: How Hidden Fractures Still Threaten the World Economy, Princeton University Press, 2010.20 Blundell-Wignall, pp. 29-57.21 Ibid., p. 30.22 Many small and medium-sized banks like Hudson Bank, for example. 23 A Special Purpose Vehicle is a legal entity usually created by a bank engaged in structured finance into which a portfolio of assets providing known cash flows are sold (“true sale” or nonrecourse to the bank), and which then issues and sells securities to investors backed by the cash flows of the underlying assets. A Special Investment Vehicle is similar to an SPV, but has a greater degree of maturity mismatch between the underlying assets providing the cash flows (e.g., mortgages) and the instruments issued to investors (e.g., commercial paper). An SIV is permanently capitalized and managed by a bank originator.24 Most large banks like Citi, HSBC, Bank of America, JPMorgan Chase, and Deutsche Bank, and larger mortgage institutions such as Countrywide, now owned by Bank of America.

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SPV loan buyers. During the 1990s, Fannie Mae and Freddie Mac eased their mortgage requirements to allow the purchase of subprime, nonconforming loans, and together their portfolio of securitized mortgages grew to about $5 trillion. The purchase of these subprime mortgages was encouraged and approved by Congress for the purpose of increasing home ownership access to lower-income, more diverse families. It achieved that objec-tive, but with catastrophic delinquency results beginning in 2007 because of the impact of upward interest rate adjustments and falling housing prices on the borrowers.

Mortgage origination became a volume-driven business with little if any regulation by the federal or state government. Loan processors were trained on the job with a target number of weekly mortgages closed set for each processor. The mortgage processor’s pay was driven by the number of mortgages completed regardless of loan quality. Soon, the size of the mortgage loan to home value ratio exceeded 100% (the historic norm is 80%), income verification of the borrower was omitted, and home appraisals were conducted with drive-by inspectors. Many of the subprime home buyers may not have even understood that their mortgage payments would auto-matically jump after the first year or after a certain period of time.25 Given the number of legal actions taken by the U.S. Department of Justice against some of the now-defunct mortgage originators, fraud was also a likely problem.

A second weak link in the mortgage supply chain was the rating agencies’ poor assessment of the degree of risk associated with the mortgages that were pooled into credit tranches during the securitization process. The ratings assigned to the credit tranches determined the cost of credit enhancement for the securitizing bank. The higher the credit rating, the lower the securitizing cost, which resulted in a larger profit margin for the securitizing bank. The rating process did not seem to change, even as the numbers of subprime or lower quality mortgage loans were added to the pool of tranched loans. As a result, the Securities and Exchange Commission (SEC) placed the rating agencies under investigation for failing to accurately assess the risk associated with credit tranches in mortgaged-backed securities. In addition, the SEC began examining their association with major banks and corporations in determining the risk of the debt instruments issued by these entities.

The third commonly identified cause of the financial crisis was the misuse of complex financial instruments to boost earnings. Associated with this issue was the compensation paid to the executives who participated in activities that increased earnings but simultaneously amplified risk. Banks that engaged in structured finance operations took several actions that made them more vulnerable to risk.

First, banks that decided to participate in structured finance in order to stay competitive had to do it in a massive way, and, once the process and support infrastructure (people and systems) was in place, it was not easy to shut it down because of its high fixed cost. Thus, the larger the process, the greater were the economies of scale. Structuring complex financial instruments better than the competition would have required hiring very technically competent executives that understood mathematics, finance, credit, debt markets, risk management, and pricing. The outstanding executives with all of these skills and proven experience were very expensive and in limited supply. In addition, there were the lawyers, operations, and technology executives needed to execute and manage these transactions through to maturity. Finally, there had to be a sales force sophisticated enough about the instruments to sell a constantly increasing volume of customized and very complex instruments to investors. The sales force also had to learn from investors what they wanted (in terms of return, cash flow, and risk level) and relay that information back to the experts that did the structuring. So, once the securitization machinery was in place, it had to be operated at full capacity to achieve economies of scale and maximize profits for the institution.

Second, some banks also thought that the return on these assumed near-risk-free instruments made them desirable investments, and so they were held by the bank. In some cases, these super-senior instruments, rated AAA by the rating agencies, were used to build bank capital so the banks could make more loans. A super-senior rating usually meant that a credit default swap (CDS) had been established, so that if there were a credit default on the underlying asset, the investor in the instrument would recover lost funds from the buyer of the swap. In most cases, the buyer was a highly leveraged hedge fund, a bank, or an insurance company like AIG or other monocline (single-purpose) insurer such as MBIA, Radian, AMBAC, PMI, and MGIG. So, the higher return the structuring bank was receiving depended on a rating agency’s accurate assessment of the underlying risk, which was questionable. It also depended on the counterparty risk of the CDS default insurance provided by insurance

25 Financial illiteracy is estimated to be around 60%-70%, even in the United States.

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companies that became oligopolistic providers of protection. In effect, it was a case of risk piled upon risk piled upon risk, all very highly correlated to a decline in housing prices—the underlying asset and collateral.

Third, another issue for banks was the competitive compensation packages they used to attract and retain the executives who were responsible for generating a substantial share of the bank’s profitability. The more cre-ative and innovative an executive was in boosting the bank’s competitive position and profitability, the larger the bonus. Cash bonuses, as opposed to stock options, were risk sensitive only in the sense that in a collapse such as the one experienced in 2007, structured finance experts were likely to lose their jobs. The CEO’s bonus, on the other hand, was less risk sensitive because it was based on the bank’s overall performance. In addition, in the late 1990s, stock options, which were exercisable only over time, fell victim to regulatory disfavor leading to a cash bonus approach. This, in effect, separated bonus compensation from risk. As a result of the bank failures and the government rescue, a Compensation Czar was created to control compensation in banks receiving any form of government support. Seeking higher—and unregulated—bonus compensation, some bankers left government-rescued banks and moved to institutions that paid more generously.

Taking a broader international perspective, the 2007-2009 crisis can be divided into related macroeco-nomic and microeconomic causes.26 The macroeconomic causes include problems associated with the buildup of imbalances in international claims. The imbalances were a result of the persistent low savings and large current account deficits in industrialized countries, and high savings with current account surpluses in emerging market countries that created large capital flows from the latter to the former. A second macroeconomic cause was the difficulty created by the long period of low interest rates. The low rates were most likely the result of fear of defla-tion during the first half of the decade. However, persistent low interest rates contributed to an underestimation, and therefore an underpricing of risk.

The microeconomic causes included risk-taking compensation incentives, inadequate risk measurement, and lack of oversight, which have already been discussed. The BIS (Bank for International Settlements) identified four causes of the large macroeconomic capital flows which transferred the securitized mortgage risk globally. First, there was a global savings glut in emerging markets (i.e., China). Second, there were widespread investment opportunities. Third was the fast-growing emerging market countries’ desire for both international diversifica-tion and low-risk liquid assets. And fourth, there was the emerging market economies’ accumulation of foreign exchange reserves to fight appreciation of their currencies due to their large current account surpluses.27 There was also an issue of mispriced risk of assets: “…if one country is producing assets that are grossly mispriced (relative to risk) and whose quality is lower than is generally perceived, they can act as a virus carrying the disease abroad from the country of issue.”28

The relative size and importance (trade and finance interlinkages) of the U.S. economy and dominance of the U.S. dollar in global transactions amplified the impact of low interest rates in the United States. There were a number of cascading consequences. First, low rates resulted in a credit boom in a number of industrial countries. Second, cheap credit supported the housing boom and consumer credit expansion. Third, low inter-est rates also increased the present discounted value of revenue streams arising from earning assets driving up asset prices (housing and stock prices). Fourth, with low interest rates, investors took on more risk to generate increased returns to create profits, probably because they undervalued the cost of risk.29 The resulting boom from these developments made macroeconomic policy management more difficult because the high growth rates did not have a solid foundation. High productivity growth in technology, and then finance, resulted in bubbles be-ing created in these sectors as well.

The Value and Importance of Structured FinanceIn January 1992, a change occurred in how larger commercial banks were regulated. This change was driven by the Bank for International Settlements (BIS), an international organization of the central bankers and ministers of finance for the major industrial countries. The BIS Basel Committee of Bank Supervision (Basel I), working through the central banks of the major industrial countries, set capital requirements related to credit risk for 26 Bank for International Settlements, 79th Annual Report, Basel, June 29, 2009, Chapter 1, pp. 4-15.27 Ibid., p. 5.28 Ibid.29 Ibid., p. 6.

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commercial banks. Large banks were required to have a minimum of 8% capital backing their assets (loans). Well-capitalized institutions normally had more than 10% capital.

Each loan made by the bank had to be placed in one of four risk categories. The higher the risk category, the more capital a bank needed, up to a maximum of 8%. The five risk categories and the capital required identi-fied by the BIS were: 0% capital required against cash or claims on the central government or central bank; 10% capital on claims on public sector entities; 20% capital on claims on multilateral banks; 50% on loans secured by a mortgage on residential property; and 100% for any claims on the private sector.

As a result of Basel I risk-adjusted capital adequacy rules, bank profitability was reduced because of the increased cost of capital associated with private sector lending. Consequently, banks began to focus on growing fee-based income or off-balance sheet activities to accommodate private sector borrowers. From its tentative begin-nings in the late 1970s, securitization became a vital funding source with an estimated outstanding debt of more than $4 trillion in the United States and $1 trillion in Europe as of the end of 2009. Securitization is a structured finance process that distributes risk by aggregating debt instruments in a pool, then issuing new securities backed by the pool. The debt instruments are sold to a trust via a special purpose vehicle (SPV). SPVs are bankruptcy remote, which means that in case a parent company goes bankrupt, the creditors of a parent company cannot claim the assets of SPV. The creation of SPV removes debt instruments from the bank’s balance sheet and frees up capital to support more loans. The result is an improvement in the profitability of the bank because banks earn fees from the securitization process, while at the same time credit risk to the bank gets reduced. Through the use of off-balance sheet conduits, securitization spreads the risk pressures through different channels and passes income to investors in a form that confers tax advantages. Securitization also provides the private sector with additional funding at a lower cost in support of economic growth and job creation.

Securitization offers a number of benefits to the issuer. It reduces the cost of funding by enabling the issuer to borrow at AAA rates. Securitization can also confer a reduction in the asset-liability mismatch by eliminating or reducing funding exposure of duration and on a pricing basis. Because securitization is a true sale of assets from a legal and an accounting basis, it lowers capital requirements by removing assets from the balance sheet. For securitized assets, profits can be locked in for the company, thereby providing budgeting certainty. Thus, securitization provides the company with immediate liquidity by removing the delay due to collections and at a borrowing cost below what they would otherwise have to pay based on their credit rating.

Securitization can also transfer various forms of risk to an investor who desires the risk and is better able to bear it. This provides the issuer with the opportunity to generate more profits, and thereby restructure itself into more profitable lines of business. Securitization does require large-size transactions, and therefore is generally not beneficial for smaller or medium-sized businesses.

Finally, if the assets are not securitized properly, then there are risks to the issuer which include counter-party risk and reputational risk. Various forms of credit enhancements and cash flow protection also protect the investor from specific adverse events. During the 2007-2009 financial crisis, however, an unexpected systemic risk emerged, affecting both issuer and investors. Despite the portfolio diversification and the credit and liquidity enhancements to the securitized assets, there was a general meltdown of securitization due to external economic and internal financial market factors. As adjustable rate mortgages jumped from very low teaser rates, home prices fell and loan-to-value ratios deteriorated, limiting refinancing. Then, as people began to be laid off and lose most of their income, the default rate rose rapidly, resulting in a movement up the waterfall tranche credit stairs, until finally the cash flow of even the super-senior CDS-backed tranche was called into question. Investors stopped buying the securities sold via SPV or SIV, and the securitization market came to a standstill, and by the end of 2010, still had not fully recovered for residential mortgages.

Uncertain Changes in Financial Services RegulationWith this crisis, the destruction of financial capital was massive, rapid, and global. How to get out of the crisis and reduce the probability of future crises is being discussed by most governments and major international or-ganizations. The global financial infrastructure and interconnectedness of financial service providers is a major issue that involves many interested parties: governments, central banks, shareholders, taxpayers, bond holders,

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and depositors.30 Past solvency crises identify three steps required to achieve recovery: insure deposits to prevent runs on banks; remove bad assets from banks; and recapitalize banks.31

While valuation of the bad assets, including the conduits, is not easy, two approaches are possible: national-ization (e.g., Resolution Trust Corporation—RTC), or an asset management approach in which funds are either sold in open market auction, bad assets are ring-fenced (government guarantees a first loss amount), or strong banks acquire weaker institutions. Some of the key issues faced in defining future longer-term regulation include separating high-risk from traditional banking, enlarging bank capital buffers, adopting more stringent liquidity requirements, strengthening consumer protection, and improving financial education.

All approaches have disadvantages, and they all take time, as has been learned from past banking crises. Once the impaired assets are dealt with, the banks need to be recapitalized, including a significant cushion of adequate liquidity levels. Dynamic provisioning, liquidity management and capital building are a remedy for pro-cyclicality issues.32 They may also help control the risk of cross-border contamination through financial conglomerates.

Government’s regulatory reform of the financial system is likely to focus, at a macroprudential level, on reducing systemic risk and better detection. At the microprudential level, which examines how financial institu-tions operate, regulations are likely to focus on:

• preventingexcessleverage• addressingmarketdisciplineandinformationgaps• strengtheningcross-borderandcross-functionalregulation• improvingsystemicliquiditymanagement• clearingfacilityandearlywarningexerciseswiththeFinancialStabilityBoard• reducingfundingmismatches• reducingcounterpartyrisk• makingbanksandinstrumentsmoretransparent• simplifyingfinancialinstrumentsfromthepre-crisesperiod

Financial institutions will be required to improve risk management systems and dedicate thorough atten-tion to governance and remuneration policies.

Detecting systemic risk will require developing standard financial soundness indicators that must include forward-looking market data, recognition of the interlinkages among banking institutions globally, a mechanism for signaling capacity of proxies for market conditions and risk appetite, and stress testing to ensure that financial institutions are adequately prepared.

At the beginning of 2008, new accounting rule SFAS157 required banks to begin dividing assets into three levels based on:

• Level1:assetprice,tradingfrequency,andmark-to-market;• Level2:partlytradedandmark-to-model;and• Level3:bankjudgment,includingmortgagesecurities,securitizedcreditcardreceivables,LBObridge

loans, complex derivative products, and the like33

The size of Level 3 assets and its growth would be audited carefully by national bank supervisors, the BIS, and IMF.

30 This section draws heavily on several reports that were issued during 2009 by central banks, international organizations, and governments. A good summary of the different discussions and positions is provided by Adrian Blundell-Wignall, Paul Atkinson, and Se Hoon Lee, “Dealing with the Financial Crisis and Thinking about the Exit Strategy,” Financial Market Trends, OECD Journal, Volume 2009/1, pp. 11-28; and Gert Wehinger, “The Turmoil and the Financial Industry: Developments and Policy Responses,” Financial Market Trends, OECD Journal, Volume 2009/1, pp. 29-60.31 Ibid., p. 13.32 Ibid., p. 23.33 Blundell-Wignall, pp. 46-47.

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Reducing systemic risk would require better macroprudential monetary policy management. This would mean determining who would be the lead systemic risk regulator, establishing metrics to define and measure systemic risk, setting standards for excess capital to deter too-connected-to-fail scenarios, and defining systemically important institutions and the perimeter of prudential regulation to include investment banks. It would also re-quire assessing the systemic implications of financial linkages, which might include the following approaches:

• networkapproach—trackslinkagesintheinterbankmarket• co-riskmodel—trackslinkagesamongfinancialinstitutionsunderextremeevents• distressdependencematrix—examinespairsofinstitutions’probabilitiesofdistress• defaultintensitymodel—tracksprobabilityoffailuresofalargefractionoffinancialinstitutionsdueto

both direct and indirect systemic linkages

Structured Finance in the FutureThe revival and future use of structured products as a risk transfer and credit expansion instrument depends on a restoration of investor confidence in them. It also depends on the costs associated with the changes required to restore this confidence and implement the new regulations. There is little doubt of the important role played by securitization in bank wholesale funding and credit extension under a capital-constrained system. In the United States, securitization accounted for about 30% of total credit outstanding before the 2007-2009 financial crisis. “Securitization, when done prudently, still presents benefits for pooling and distributing credit risk and for of-fering banks an alternative source of financing.”34 It is of vital importance to the real estate and consumer credit markets.

Some of the actions taken primarily by the Federal Reserve and, to a lesser extent, the U.S. Treasury in-clude:

• liquidityswapsofsecuritizedassetsfortreasurycollateral• liquidityandloanstobankstopurchaseasset-backedcommercialpaper(ABCP)frommoneymarket

mutual funds (MMMF)• liquiditytoFed-sponsoredspecialpurposevehiclestopurchase3-monthcommercialpaper• liquidityintheformofloanstoinvestorstopurchasenonmortgage-backedasset-backedsecurities(ABS)

and commercial mortgage-backed securities (CMBS)• purchasesofGovernment-SponsoredEnterprises(GSE)35 obligations—$200 billion authorized; outright

purchase of GSE mortgage-backed securities (MBS)—$200 billion and $1.25 trillion authorized, respectively

• capitalandfinancingforprivatesectorpartnerstopurchaselegacyCMBSandprivate-labelresidentialmortgage-backed securities (RMBS)36

Another effort to reduce the legacy asset overhang was to resecuritize the senior private-label mortgage-backed security tranches that experienced a rating downgrade. This process, called RE-REMIC (Resecuritization of Real Estate Mortgage Investment Conduits), was driven by the need to maintain the AAA rating required by some of the investors, but it could also result in capital reduction requirements for banks. The RE-REMIC process divided the downgraded security into a new senior AAA tranche representing about 65% of the original senior AAA tranche, which usually accounted for about 70% of the original security. The remaining 5% then become a new mezzanine tranche which could be sold to a hedge fund. This meant that only 30% of the original security needed to be sold at distressed prices. Under new Basel II rules, a BB rating had a 350% capital requirement, whereas there was only a 40% capital requirement for tranches rated under a AAA securitization. 37

34 IMF, “Navigating the Challenges Ahead,” Global Financial Stability Report, Washington DC, October 2009, p. 32. 35 Such as Fannie May and Freddie Mack-securitized instruments.36 Ibid., pp. 32-33.37 IMF, “Policy Initiatives Aimed at Restarting Sustainable Securitization,” Global Financial Stability Report, Washington DC, October 2009, pp. 77-115. See also in the same source, the “Box 2.4: Covered Bond Primer,” pp. 90-91. Structured covered bond activity has risen in recent years as an alternative to securitization. Covered bonds have two sources of protection: the obligation to repay, and specific collateral “covered pool” legally ring-fenced to protect the investor. One major difference is that they do not come off the balance sheet. See also http://www.theatlantic.com/business/archive/2009/10/re-remics-really/27639/.

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The main problem behind the loss of confidence was a severe deterioration of the credit quality of the underlying assets, aggravated by the loss of confidence in the financial system with the failure of Bear Sterns and Lehman Brothers. Subprime and Alt-A mortgages, which expanded rapidly, accounted for about 20% of the nearly $4 trillion total outstanding securitized products.38 Steps have been taken by governments to restore confidence in the outstanding securitized products, but new securitizations must be modified to improve investor confidence before the market will recover. Time is critical to restore confidence in securitization, given an economic recovery which may be neither smooth nor quick. Economic recovery will help restore confidence in banks as they build capital, as nonperforming loans decline, and as the uncertainty in the supply of credit ends.

Restoring investor confidence in securitization may require several changes in the process. There are four segments to the securitization process: pooling of assets (cash or synthetic); delinking of credit risk from the originator; tranching the liabilities backed by the asset pool; and the quality and maturity mismatch between the underlying asset and the product sold to the investor. The main issues in the tranching process are the priority ordering of tranches by risk or allocation of losses: equity or first loss, mezzanine tranches or second loss, and senior or safest tranches. Although there are currently various forms of credit support in use, simply estimating the loss distribution of the asset pool may be insufficient. It may also be necessary now to model the distribution of cash flows from the asset pool to the tranches under different scenarios.39

Securitization involves managing a large number of participants and tracking the flow of information to all parties, which is difficult. Greater transparency about the makeup of the tranche is required, and perhaps only smaller portions of the portfolios should be securitized. Of course, transparency is dulled when the structured tranches contain tranches from other securitizations.40 Furthermore, the compensation incentives should shift from driving the originate-to-distribute high-volume model to more selective higher quality parts of the total portfolio. The credit rating system also needs to improve and be more forward looking. Again, more transparency regarding the rating methodologies used and their related risks and vulnerabilities is required. The issue raised is whether “…tranching causes ratings of structured securities to behave differently from traditional corporate bond ratings.”41 The result could be mispriced and mismanaged risk. Investors relied on the credit rating to make a decision, and had too little information about the structure to be able to ask questions about the risks or underlying assumptions. However, the lack of transparency as to who owns what and what losses in a mark-to-market sense might look like is causing uncertainty for existing and would-be investors and lenders.42

In order for investors to return to the securitization market, less complexity is required.43 This may mean fewer tranches, reduced use of special structural features, more transparency of the underlying assets in the tranches, and less complex structures than those developed during the last decade. This would suggest more standardization of the information package on the structure and of the structures themselves. Better ratings of the tranches are required, along with how they were derived and their related risk properties. It has been recom-mended that rating agencies need to be supervised by the government. Several proposals from the European Parliament, U.S. Treasury, and International Organization of Securities Commissions (IOSOC) suggest that the originator and the structuring body should retain some portion of the securitization. It is important that the incentives of originators and end investors be more closely aligned.

The question is, how much should be retained and in what form should retention take place to ensure the greatest impact on restoration of investor confidence. Several alternatives have been proposed, including requiring retention of the equity or first-loss tranche. However, the significance of this measure would depend on the size of the equity tranche relative to the securitized portfolio. Three alternatives arise, each with a different sensitivity

38 “Highly-leveraged loans (subprime and Alt-A) are very desirable for a CDO structure because…high-yield spreads are necessary for the conduits to pay cash streams to investors and remain profitable.” Blundell-Wignall, p. 33.39 Bank for International Settlements, “The Future of Securitization: How to Align Incentives,” BIS Quarterly Review, Basel, September 2009, pp. 29-43. 40 Ibid., p. 32.41 Ibid., pp. 32-33.42 Blundell-Wignall, p. 43.43 The major players in a complex structure include originators, conduits, investment banks, rating agencies, insurers, liquidity providers, sales agents, and trusts, and each have many subplayers to support their function. Blundell-Wignall, pp. 34-38.

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to the business cycle: retention should include a vertical slice, equity tranche, and mezzanine tranche.44 The size of the potential loss or the discipline on the originators and securitizers is a function of the width and size of the slice retained. For example, if the equity tranche is relatively small, a wide slice is almost meaningless. If there is too high a cap placed on retention, then the incentive and benefits of securitization become questionable to the structuring bank.45

Some Basel II securitization and resecuritization-related enhancements have already been enacted. Risk weights attached to these exposures have been increased because they were believed to be necessary. Opportuni-ties for regulatory arbitrage across the trading and banking books between liquidity facilities with short- versus long-term maturities and across on- and off-balance sheet entities have been addressed.46 In addition, in the U.S., the Federal Accounting Standards Board (FASB) eliminated the ability to report the gain-on-sale accounting treatment that had added to the profitability of securitization. This will not only remove a benefit to securitizing bank profits, but will also reduce an immediate compensation benefit. There is a concern that this new regulatory structure may make some securitizations too costly to be used by banks and corporations.

OutcomeRajani finished his research and was left with many questions (see below), but it was his feeling that securitization remained a very useful financial tool and would continue to be used. Nevertheless, some of the incentives which supported securitization’s growing use by financial institutions and corporations would possibly be diminished because increased regulation raises the cost of issuance. Rajani now had to return to work and begin contact-ing his customers to share his arguments for the future of securitization as a competitive financing instrument. What should he say? What are the important issues and arguments? How should Rajani answer these important questions?

Questions1. Do you believe that structured products, specifically securitization, will ever return to its former importance?

What are the pros and cons ethically and functionally? What will replace its important role of function in financing?

2. How will the proposed increased regulation (2010) affect value of structured finance instruments to both originator and issuer? Would it affect their usefulness as a source of financing and diversification/transfer of credit risk? Analyze and explain.

3. What credit enhancements/options can an issuer use in order to increase buyer confidence and enhance market liquidity? Discuss and explain.

4. What changes have been proposed and implemented for the rating agencies, and will these prevent the deficiencies of the past? Analyze and explain.

5. Will investors return to purchasing financial products back for the cash flows related to securitized residential or commercial mortgages? Analyze and discuss.

ReferencesAkerlof, George A., and Robert J. Shiller, Animal Spirits, Princeton University Press, 2009.Bank for International Settlements, 79th Annual Report, Basel, Switzerland, June 29, 2009.El-Erian, Mohamed A., When Markets Collide, McGraw Hill, 2008.Fender, Ingo, and Janet Mitchell, “The Future of Securitization: How to Align Incentives?” BIS Quarterly Review,

September 2009, pp. 27-44.Goldman Sachs, Effective Regulation: Part 3 Helping to Restore Transparency, June 2009.International Organization of Securities Commissions, Unregulated Financial Markets and Products, May

2009.

44 BIS, pp. 36-41.45 IMF, p. 96. A summary of Securitization Policy Progress Report is presented in Table 2.1 in the report.46 IMF, pp. 98-99.

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International Monetary Fund, “Responding to the Financial Crisis and Measuring Systemic Risks,” Global Fi-nancial Stability Report, Washington DC, April 2009.

Paulson, Jr., Henry M., On the Brink, Business Plus, 2010.Shin, Hyun Song, “Securitization and Financial Stability,” The Economic Journal, March 2009, Volume 119,

Issue 536, pp. 309-32.Sorkin, Andrew Ross, Too Big To Fail, Viking, 2009.Taleb, Nassim Nicholas, The Black Swan, Random House, 2007.Tett, Gillian, Fool’s Gold, Free Press, 2009.U.S. Treasury, Financial Regulatory Reform: A New Foundation, Washington DC, June 2009.