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Securitization

Securitization

Definition

A process whereby periodic cash flows from a given source are pooled, packaged, and sold to investors, usually in the form of bonds. Between 2003 and 2006, large numbers of subprime mortgage loans were pooled in this manner and then sold to investors who, in return for paying an up-front principal amount, received periodic payments (usually quarterly) in the same manner as bondholders. By 2006, approximately 63 percent of all subprime loans were being sold and packaged in this fashion. When a wave of subprime mortgage loan defaults began in 2007, the value of the bonds began to plummet because the cash flows that "securitized" the bonds (i.e., the periodic monthly payments from the subprime loans) were substantially lower than anticipated, given massive numbers of loan defaults, and were therefore insufficient to pay the interest required by the bonds. This, in turn, triggered huge losses for the investors who bought these bonds. As a result, the investors brought literally hundreds of class action lawsuits against the directors and officers of both the banks that made the subprime loans and the investment bankers who packaged the loans into bonds.

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