Why Do I Keep Hearing How Critical Securitization Is?

Since frozen credit markets began to be covered by the media last fall, I keep hearing talking heads on TV say that this or that credit market needs to be loosened up – and I agree.  Right now there’s not enough free-flowing capital in the system to promote general economic growth.

But I also hear economists and others saying the securitization market needs to be ginned back up.  They seem to talk about securitization as if it yields the same economic value as, say, credit which should be going to small business loans.  Paul Krugman’s column in the Times today got me thinking about whether or not a securitization free-for-all is what will really help the structural economy.  Krugman points out that banking and insurance used to be “staid” professions.  In the 1960′s financial services were 4% of GDP, now they are 8%.  It’s obvious that economic activity benefited relatively few and brought us to the brink of collapse last year.  Whereas if there were to be a doubling of manufacturing’s portion of GDP, everyone benefits – from the plant owners to the guys sweeping the floors at night.

Deregulation of financial services spawned big numbers, but for whom?  I’m not sure how Obama Administration plans to take care of toxic assets and the other gremlins in our current economy get at the fundamental unfairness of the structural U.S. economy.

A little context from Krugman:

Underlying the glamorous new world of finance was the process of securitization. Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans — all went into the financial system’s juicer. Out the other end, supposedly, came sweet-tasting AAA investments. And financial wizards were lavishly rewarded for overseeing the process.

But the wizards were frauds, whether they knew it or not, and their magic turned out to be no more than a collection of cheap stage tricks. Above all, the key promise of securitization — that it would make the financial system more robust by spreading risk more widely — turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.