Definition
Securitization is the financial practice of bundling many individual loans, such as mortgages, car loans, or credit-card balances, into a single pool and issuing securities backed by the cash flows from that pool. Investors buy the securities and receive a stream of payments.
It transforms illiquid assets, loans that are hard to sell one by one, into standardized instruments that can be traded on financial markets.
Why it matters
How it works
A lender sells a pool of loans to a special-purpose entity, which issues securities against them. The pool is often sliced into tranches with different risk and return, so safer tranches absorb losses last and riskier ones first.
The benefits, liquidity and risk-sharing, come with hazards. When originators no longer hold the loans they make, their incentive to screen borrowers weakens, a moral-hazard problem. Opaque, complex pools made the 2008 crisis worse because investors could not gauge the true risk they held.