"Securitization has swept the world of finance over the past several decades. There is no better guide to the legal intricacies of this revolution than the second edition of Tamar Frankel's Securitization. It is essential reading not only for those wanting to get up to speed on the subject, but should be at the side of every legal and business practitioner in this burgeoning field."
Economic Studies Program,
The Brookings Institution
Vice President for Research and Policy, The Kauffman Foundation
Securitization: A Comprehensive Treatise
The recent sub-prime crisis made mortgage-backed securities a house-hold word. The subject is of crucial interest to law firms and Wall Street firms, banks, insurance companies and broker dealers, as well as to rating agencies, real estate appraisers and the regulators.
Securitization is part of the financial system, whose purpose is to transfer money from savers—those who postpone consumption—to borrowers—who need money for productive purposes, or for consumption (which creates production). Savers—investors—pay borrowers for the borrowers obligations (to return the money with interest or profits).
The financial system offers borrowers and savers two avenues for borrowers to interact: the markets and institutions, such as banks. Markets arise only if certain conditions are present (e.g., standard forms of obligations, and relatively low-cost information about the borrowers). If these conditions are absent, institutions borrow from savers (offer deposit services) and, turning around, use the money to lend to borrowers.
Securitization and structured finance have emerged as a new system that substitutes markets for institutions or combines parts of both in new ways. The process is simple. It starts with loans. Thus, sub-prime loans were made by banks, and mortgage banks, for example. These loans are then transferred to a trust or corporation called Special Purpose Vehicle (or Entity). This Special Purpose Vehicle then issues securities backed by the loans it holds to investors (publicly or privately). A servicer collects the payments from the borrowers and transfers the money to the holders of the securities.
Simple. Yet, the devil, as always, is in the details. The process involves various structures, difficulties of valuations, appraisals and terms. It involves different regulatory regimes. Each stage of the process and the process as a whole raise legal issues.
Securitization by Tamar Frankel (2d ed.) (Ann Schwing editor) (2006) (Fathom Publishing Company) is a classic treatise on securitization. It is a comprehensive two volume work combining the law with the analysis of the securitization process, highlighting practical issues. The treatise contains a thorough and full discussion of judicial and legislative legal material concerning securitization. Far before the sub-prime crisis, the first edition (1991) pointed to potential risks that materialized in the sub-prime crisis, and suggested responses. For example, more than ten years ago, Frankel noted the risk of lenders and brokers who produce and sell loans without bearing any of the loans’ risks. The treatise highlighted the unique process of securitization that transforms contract relationships (loans) into property relationships (securities), and analyzed the different public policies that underlie the two legal categories. Frankel predicted the difficulties of re-structuring securitized loans because the process severed the lenders from the borrowers.
Frankel’s treatise details the history of securitization, the role of government corporations in developing the system (e.g., Fannie Mae), and the legal problems that arise in every juncture of the process. The story of securitization starts with the lenders—banks’ making, selling and securitizing loans—follows the creation of various forms of the entities to which the loans are being transferred and the laws that affect these entities including exemption from regulation as investment companies. The treatise analyzes the structure of the entities, the different securities that they issue to investors, and the laws governing the distribution of their securities. There is a discussion of the servicers—usually the banks—that collect the payments from the borrowers and distribute the payments to the investors. There are chapters on the possible bankruptcy of the sellers of the loans to the entity and the dangers to the investors from claims of the sellers’ creditors. There is a full discussion of the laws of foreclosures.
In addition, the treatise covers inter-bank participations of large loans, the status of the lead banks that control the contact with the large borrowers, as well as the rights and problems of the borrowers and the holders of the loan participations. The last chapter of the treatise is devoted to securitization in other countries. This process has been of great interest to China (where the Frankel treatise is now being translated) as well as other countries in the far east and Europe. In sum, the treatise is a comprehensive work on the subject.
When the first edition of Securitization was published, this financial form was hardly known, let alone understood. Fifteen years later, securitized assets markets constitute one of the largest financial markets and the largest, if mortgage-backed securities are included. The updates of the treatise throughout the years did not do justice to the developing subject.
Hence, this second edition. The fundamental theoretical approach of the treatise has remained the same. This second edition does, however, contain added theoretical arguments and numerous additional citations. The basic structure of the treatise has remained mostly intact although four chapters have been consolidated into two. Redundancies have been eliminated by references. Authorities have been added and updated.
The treatise has received the masterful edit of Ann Taylor Schwing which makes for easier research and reading.