Handout Professor Minsky prepared for Econ 335A, Fall 1987.
Minsky, Hyman P. Ph.D., "Securitization" (1987). Hyman P. Minsky Archive. Paper 15.
Handout Econ 335A-Fall 1987
Hyman P. Minsky
St . Louis MO 63130
Notes prepared for discussion. First on June 27, 1987 then
edited and expanded in August 1987. Corrected in September
Heraclitus: “You can not step twice in the same river."
IN MAY 1987. AT THE ANNUAL BANKING STRUCTURE AND COMPETETION
CONFERENCE oF THE FEDERAL RESERVE BANK OF CHICAGO. THE
BUZZWORD IN THE CORRIDORS AND BY MANY OF THE SPEAKERS WAS
"THAT WHICH CAN BE SECURITIZED. WILL BE SECURITIZED".
It is necessary to understand what securitization involves
and how it might affect the development of the world economy
if central bank interventions and the government
interventions that guide institutional developments are to
be successful. Thus there is a broader significance to the
emergence of securitization than the impact it will have on
banking and other financial businesses.
Securitization leads to the creation of financial paper that
seems to be eminently suitable for a global financial
structure. There may be a symbiotic relation between the
globalization of the world's financial structure and the
securitization of financial instruments. Globalization
requires the conformaty (sic) of institutions across national
lines and in particular the ability of creditors to capture
assets that underlay the securities.
Securitization reflects a change in the weight of market and
bank funding capabilities: market funding capabilities have
increased relative to the funding abilities of banks and
depository financial intermediaries. If securitization
reaches the potential that some envisage for it then the
shift of funding to market from institutions will be very
great. The institutions that survive will be largely
dependent upon fee income.
Securitization is in part a lagged response to monetarism
and inflation. monetarism led to fighting inflation by
constraining monetary growth which, in monetarist doctrine
meant that the growth of bank and thrift institution
liabilities had to be constrained. This constraint on the
growth of banks and thrifts opened opportunities for
financing techniques that economized on bank or thrift
liabilities. The monetarist way of fighting inflation,
which preceeded (sic) Volcker's 1979 "practical monetarism", puts
banks at a competetive (sic) disadvantage in terms of the short
term growth of their ability to fund assets. Furthermore by
opening interest rate wedges monetary constraint provides
profit opportunities for innovative financing techniques.
In the United States the interest rates of the monetarist
experiment impaired the net worth and therefor destroyed the
funding capabilities of the thrift "industry" by undermining
the value of mortgages. However the ability of the thrifts
to create mortgages was unimpaired. Securitization as we
know it began in the U.S. mortgage market. It enabled the
thrifts to continue to initiate mortgages even though their
funding ability was sorely Compromised. Although modern
securitization may have begun with the thrifts, it has now
expanded well beyond the thrifts and mortgages.
Securitization is also a market response to the cost
structure of banks. Banks seem to need a 450 basis point
margin if fund income is to be the source of profits. This
provides a great deal of space between the price banks pay
for funds and the price they must charge borrowing customers
for innovative suppliers. Bank participation in
securitization is part of the drive, forced by costs, to
supplement fund income with fee income.
The development of the money market funds, the continued
growth of mutual and pension funds, and the emergence of
vast institutional holdings by offshore entities provide a
market for the instruments created by securitization.
Any attempt to place securitization in context needs to
start with early 19th century commercial bill banking in
Britain and a recognition that accepting contingent
liabilities is a fundamental banking act and that this
acceptance enhances the creditworthiness of the initial
instument (sic). The modern contribution is the development of
techniques to "enhance credits" without accepting contingent
liabilities or the creation of equity liabilities.
Securitization throws light on the nature of money: Money
is a financial instrument (a debt) that develops out of the
financing of activity and positions in assets that becomes
generally accepted in an economic community as a means of
payment for goods and services and as an instrument by which
debts are discharged. It is conceivable that in the not too
distant future we can be using $100. (sic) interest bearing short
term securities as currency. Private money is a distinct
possible longer run implication of current developments.
Securitization implies that there is no limit to bank
initiative in creating credits for
1. there is no recourse to and therefor no absorption
of bank capital and
2. the credits do not absorb high powered money.
Both capital and reserve absorption may occur at the
initiating stage of the credit. This has led to the "bridge
Securitization lowers the weight in the total financial
structure of that part which Central Banks (Federal Reserve
In the United States) are commited (sic) to protect.
Institutional holders of securities (such as mutual or money
market funds or trustees for pension funds) who are
Committed to protect the market value of their assets may
react to a rise in interest rates by selling their position,
which can lead to a drastic fall in the price of the
securities. Is the danger that units will be forced to make
position by selling out position increased by the
development of securitization?
The new technologies of communication, computation and
record keeping are important in the emergence of
securitization and globalization .
The two fundamental banking interfaces
(Bank is a generic term not restricted to legally defined
I. "Bank" and debtors.
1.The initial creation of paper based on cash flows
from income creating activities
The liability is of :
a. Business and therefor is a prior
allocation of profits
b. Households and therefor is a prior
allocation of wages etc.
c (sic) Government and therefor is a prior
allocation of taxes
d (sic) The rest of the world and therefor is a
prior allocation of export earnings
2.Note that such paper links the present and the
future. Today is the future for some past todays. Prior
commitments are falling due even as new commitments are
entered upon. Cash flows as both a source of funds and as
the validation of prior Commitments. The hedge, speculative
and Ponzi characterization of cash flows may be relevant.
3. A banker operates on the basis of expectations of
cash flows. What determines such expectations? In
particular "How do expectations change?" is a fundamental
analytical-banking question in a market based financial
4. In banking collateral is of secondary importance in
the creation of credit for the bank customer relation has
failed whenever there is a need to capture collateral. The
importance of collateral is that it furnishes a way to wipe
out failed credits. The weakness of the way the sovereign
Latin American debts were structured is that they did not
provide for any way by which failed debts could be
recognized and therefor wiped out. Real progress on Latin
American debts and the availability of new credits to Latin
America depend upon the invention of some "bankruptcy
proceedure" (sic) which recognizes failed credits and wipes them
off of the lenders books.
5. Asset or collateral based lending implies that the
cash flows to validate commitments will be forthcoming from
the sale of the asset. The buyer obviously expects cash
flows that will validate the price he pays.
II. Bank and "Funders".
1. Households as the ultimate owners;
2. Intermediation and layers of intermediaries; the
descriptive insights of Gurley and Shaw on the one hand and
Goldsmith on the other.
III. The relations
1. A bank deals with both the issuer of debts and the
funder; a bank's balance sheet reflects this two sidedness
of banking. Fund income depends upon the gap between the
cost of money and the return on earning assets. Bank equity
“enhances credits”. Deposit insurance as the enhancer of
credit for today's bankrupt banks and savings and loan
associations in the United States. Deposit insurance as a
government guarantee rather than insurance. "What are the
actuarial relations?" was never addressed in deposit
2. In securitization the bank's balance sheet
disappears from the financing once the transactions are
completed. No question of contingent liabilities and
recourse if there is no fraud.
3. In securitization financial instruments and the cash
flows they are expected to generate are the proximate basis
for issuing marketable paper. Income from paper (cash
flows) is substited (sic) for the profits earned by real assets,
household incomes, or tax receipts as the source of the cash
flow the paper pledges.
The steps and the players
1: A. debtor: the fundamental paper emitter and source of
the cash flows from income that validate the securities.
2: The paper creater (sic): the bank loan officer who structures
the credit and accepts debtor's promises to repay;
The negotiations between 1 and 2 ends up with paper that can
be negotiated. Steps 1 and 2 are like conventional bank
Query: If a credit is to be securitized will the "loan
officer" be as prudent as he would have been if the paper
was going into his institutions portfolio?
3: The investment banker: (NOTE THAT THE INVESTMENT BANKER
INTERFACES WITH MANY DIFFERENT TYPES OF UNITS. )
finds and negotiates with the paper creater (sic), buys the paper (bridge financing, the funding
of bridge financing, the relation to commercial banks,
exposure, out the window are terms that enter here).
The paper becomes the corpus
of a trust. (In Britain a separate corporation may be set
up for each corpus. In this case there may be an actual
On the basis of the assets in
trust the investment banker creates securities, devising
ways to enhance credit (insurance, Complex of liabilities,
erzatz (sic) equity in the form of junk bonds)
The investment banker hires "econometricians" or financial economists to demonstrate
that the risks of default on interest and principle of some
class of the securities it proposes to issue are so small
that these instruments deserve to have an investment rating
that implies a low interest rate.
Securitization is viable, profitable for all concerned if the total cash pledged by
the securities is less than the total cash the corpus of the
trust is expected to yield.
4: The trustee: holds the basic paper-the corpus of
collateral for the securities-; acts in the interest of the
security holders; recieves (sic) the cash flows from the
underlying instruments, forwards them to the security
holders, empowered to end the trust, sellout the corpus,
and transmit proceeds to security holders according to the
hierarchy of rights if the rating of securities fall below
some agreed level. If the corpus of the collateral are
instrUments such as mortgages which provide for the periodic
repayment of principle then the trustee will call the
remaining libilties (sic) and liquidate the trust when the
principle outstanding falls below some stated value.
If securitization spreads the trustee business will boom.
The need to develop equivalents to the U.S. trust Company if
securitization is to be truly global.
5: The servicing organization: (often the paper creater)
recieves (sic) payments from the corpus and transmits the funds to
the trustee. Also may be the agent who acts for the trust
if paper in the corpus doesn't perform. This is a source of
6: The rating services: places the resulting securities
into risk classes. In the security contract there is a
commitment to keep at least some of the securities in some
particular set of low risk classes. If the securities fall
below some rating or perhaps are threatened to fall below
some rating the trustee is supposed to act to protect the
interests of the security holders. This may lead to the
sale of the underlying assets, the corpus of the trust.
There is a danger that the equivalent of making position by
selling out position will result.
7: The maker of a secondary market. Often the underwriter,
the initiating investment banker. This is usually? (sic) a dealer
not a broker market. This will be a thin market if price
and quality of the securities deteriorate.
8: T (sic)
he funders: household, pension fund, banks with poor paper
creating facilities, mutual funds, foreign institutions etc.