The role of U.S. securitized assets in the Global Financial Crisis: Part 3

How did the various securitized sectors fare during the Global Financial Crisis?

Kerschner: Obviously, subprime mortgages get the most attention and energy during the GFC. Given their implosion. CMBS actually did not do very well at all either, mostly because it was just too much leverage. They didn’t think there was going to be any kind of crash in commercial real estate.

And so, when that happened, a lot of these loans defaulted. Not to the same extent as we saw in the subprime mortgage crisis because you weren’t really putting CMBS in these CDOs, but it still was an issue and did not perform well.

ABS actually performed quite well. There’s never been an auto ABS that’s ever defaulted in the history of auto ABS. But auto ABS, credit card ABS, student loan ABS, pretty much performed as expected throughout the GFC.

CLOs actually performed pretty well as well. Agency mortgages, because they had no credit risk, they were fine as well. So, the big issues during the GFC were pretty much the non-agency mortgages, the subprime mortgages, and commercial real estate.

Were any particular entities to blame?

Kerschner: The question we often get, “Who is to blame?” You know, the Wall Street banks? Is it the rating agencies? Is it the regulators? Is it all the above? Is it the money managers? And I’ll go back to if people haven’t seen the movie The Big Short, I very much recommend it. When you watch these movies and Hollywood’s depiction of what happened, it just seems like it was obvious this was all going to happen. And believe me, being in it at the time, very, very few people really knew that what ended up happening was going to happen. And even the few, handful of people, let’s call it that, that kind of knew that this was all fraught, you had to get the timing right or else it just didn’t work.

So, look, I get why people are frustrated at the bankers and the banks. They sold mortgage products that ended up defaulting. A lot of salespeople are on the record or tapes saying this is, you know, a pile of junk, but let’s sell it anyway. That’s very frustrating to investors.

The rating agencies, you could argue, look, they shouldn’t have been rating these securities without the proper data, without the proper models. That is probably true.

I think the regulators owe the biggest part of the blame. Why? Because think about Fannie and Freddie. They were private organizations at the time, giving a lot of money to politicians and regulators in terms of contributions. And the regulators basically forced Fannie and Freddie to buy a lot of subprime mortgages which caused them to go bankrupt. So, the regulators were the people that had the power to change this and say Fannie and Freddie shouldn’t be buying this. You know banks, you should have more capital if you’re going to buy these subprime mortgages or be in the CDO business. And they didn’t. They should have seen this coming and are all on the record saying this wasn’t going to be a problem. And obviously it was.

What changed in the wake of the crisis?

Kerschner: I think the one big change, and it came out of Dodd Frank, and what they call the non-QM rules, or qualified mortgage, just the underwriting that has to go into mortgages now is much more strict. So, we don’t have those subprime mortgages and they’re not coming back. So that’s the biggest change.

What are the benefits of securitization?

Kerschner: Very simply, bottom line: you want a mortgage loan, you want a car loan, you want a student loan, it’s going to be cheaper or lower rate because of securitization. Studies have been done trying to figure exactly how much. The best ones I’ve seen for mortgages are somewhere between 50 to 100 basis points, so a half percent to a percent lower.

And so that’s a good thing for people, right? It makes housing cheaper, more affordable. It makes getting a car more affordable. Importantly, it gives the end borrower lower rates.

Look, the GFC is a is a big warning pillar for our market. But there have been also … you know, people forget about WorldCom and Enron, right? That was in the early 2000s and giant corporations that had fraud and went bankrupt. You know, it’s not just our markets that have mistakes. And in general, people forget about the millions upon millions of loans that work out well and are in the end very good for people. So, I want people to remember that as well.