What Ruined The Banks

There’s lots of confused talk these days about how securitization helped cause our finanical crisis. In the “just so story” version of the credit crisis the banks securitized mortgage loans, knowing they could sell them off and avoid any real risk. In reality, however, the banks didn’t sell off the mortgage backed securities. They held them, believing that they would seriously appreciate.

Jeremy Seigel spoke to a class at Wharton recently where he explained the calamity of the banks securitize-and-hold strategy:

Financial firms bought, held and insured large quantities of risky, mortgage-related assets on borrowed money. The irony is that these financial giants had little need to hold these securities; they were already making enormous profits simply from creating, bundling and selling┬áthem. “During dot-com IPOs of the early 1990s, the firms that underwrote the stock offerings did not hold on to those stocks,” Siegel says. “They flipped them. But in the case of mortgage-backed securities, the financial firms decided these were good assets to hold. That was their fatal flaw.”

Explaining his theory further, Siegel pointed out that many troubled banks and insurers continued to prosper in almost every other aspect of their businesses right up to the 2008 meltdown. The exception was the billions of dollars in mortgage-backed securities that they bought and held on to or insured even after U.S. home prices went into a free-fall more than two years ago.

Perhaps the most troubling aspect of all this is that its clear that banks and regulators continue to hold on to exactly the same idea: these assets will appreciate, housing will go up, if we just hold them we’ll make money. The fact that this was the road to ruin apparently doesn’t cause any hesitancy to march down it all over again.

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