Securitization: A Low-Cost Sweetener for Lemons

Washington University Law Quarterly | Winter, 1996 | Vol. 74, No. 4, 1996

I. Introduction

Securitization 1 was invented in the early 1970s. 2 Since then, the transaction volume has exploded. By the end of 1994, more than $ 1.9 trillion securitization securities were outstanding, and more than $ 500 billion of securitization transactions were done in 1994 alone. 3 And securitization is expected to remain a significant source of financing in the years to come. 4

Securitization is a technique firms use to raise financing. In securitization transactions, financiers purchase securities payable from collections on a firm’s receivables. Contrasted with many other financing techniques, securitization looks very complex. 5 Complexity is rarely, if ever, costless. If financing decisions are made rationally, securitization transactions must offer benefits that simpler financing techniques do not.

Practitioners tout securitization’s ability to enable: (1) a low quality firm to, in effect, issue high quality securities, and (2) cash flow streams saleable only at sizeable discounts on lower priced financial markets to be transformed into securities saleable at much smaller discounts on higher priced capital markets. 6 The claim, more generally, is that securitization is a method for packaging cash flow streams of receivables for higher valued (and higher priced) uses, at a cost lower than the increment of value added. 7

The famous Modigliani and Miller capital structure irrelevance theorem holds that capital structure – the way a firm carves up its cash outflows into one or more layers of debt or equity – is irrelevant to firm value. 8 Financing transactions, such as securitization, are the …

133. See Michael Carroll and Alyssa A. Lappen, “Mortgage-Backed Mayhem,” Institutional Investor, July 1994, at 81.
225. Caroll & Lappen, supra note 133, at 81.

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Alyssa A. Lappen is a U.S.-based investigative journalist. She is the former Managing Editor at the Leeb Group (2012-2017); a former Senior Fellow of the American Center for Democracy (2005-2008); and a former Senior Editor of Institutional Investor (1993-1999), Working Woman (1991-1993) and Corporate Finance (1991). She served six of her 12 years at Forbes (1978-1990) as an Associate Editor. Ms. Lappen was also a staff reporter at The New Haven Register (1975-1977). During a decade as a freelance, her work appeared in Big Peace, Pajamas Media, Front Page Magazine, American Thinker, Right Side News, Family Security Matters, the Washington Times and many other Internet and print journals. Ms. Lappen also contributed to the Terror Finance Blog, among others. She supports the right of journalists worldwide to write without fear or restriction on politics, governments, international affairs, terrorism, terror financing and religious support for terrorism, among other subjects. Ms. Lappen is also an accomplished poet. Her first full-length collection, The Minstrel's Song, was published by Cross-Cultural Communications in April 2015. Her poems have been published in the 2nd 2007 edition of Blood to Remember: American Poets on the Holocaust and both 2007 issues of Wales' award-winning Seventh Quarry: Swansea Poetry Magazine. Dozens of her poems have appeared in print and online literary journals and books. She won the 2000 annual Ruah: A Journal of Spiritual Poetry chapbook award and has received a Harvard Summer Poetry Prize and several honorable mentions.

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