Securitization Wave
A securitization wave is a phase in which banks and lenders bundle an unusually large number of loans and resell them as tradable securities. Such waves finance booms quickly and cheaply, but also spread risk across the entire financial system – in 2007, this ended in the global financial crisis.
When a bank gives you a loan, it then holds a promise in its hands: you’ll pay it back in installments over the years. It can keep that promise – or sell it. To sell, it packages thousands of such loans together and slices the package into small shares that investors can buy like stocks. This process is called securitization: a loan becomes a security. A securitization wave is a phase in which this happens on a very large scale and very quickly, because many lenders want to buy such packages at the same time.
Why banks bundle these packages in the first place
For a bank, a loan it has issued is dead capital. The money is gone and only comes back over years. If it sells the loan on, it gets the money back immediately and can issue the next loan. A securitization wave therefore acts like an amplifier: the same equity capital suddenly finances a multiple of the loan volume.
This isn’t automatically bad. Without securitization, mortgages would be significantly more expensive in many countries. Car loans, student loans, and leasing contracts are also refinanced this way. Right now, such a wave is underway for AI data centers: construction costs billions, and operators securitize their customers' long-term lease agreements to pay for the construction work today.
The price for this is an incentive problem economists call “moral hazard” – roughly meaning: whoever passes on the risk scrutinizes it less carefully. A bank that resells every loan within weeks has little reason to closely vet the borrower. That’s exactly what happened on a massive scale in the American mortgage market before 2007.
From individual loan to tradable tranche
Technically, the process is always similar. The bank sets up its own small company that serves this purpose alone and sells it the loans. This company sits legally outside the bank. If it goes bankrupt, the bank is formally unaffected. The company finances the purchase by issuing securities to investors.
The crucial part is the division into so-called tranches, i.e., levels with different risk. If some borrowers stop paying, the default hits the lowest level first. Only once that level is completely used up does the next one start losing money. The top level pays little interest but is considered very safe – and is often rated with top marks by rating agencies.
Here lies the typical error. The safety of the top tranche rests on the assumption that the loans default independently of one another. But when a recession hits, many borrowers lose their ability to pay at the same time. Then the buffer of the lower levels is no longer enough, and even the “safe” securities default. In a wave, this risk grows especially fast because standards decline as volume rises.
How to spot a wave in the news
Economic reports then feature abbreviations like ABS, short for Asset-Backed Securities, meaning securities backed by assets. For mortgage loans they’re called MBS, for corporate loans CLO. Coverage usually reports record volumes: “Issuance at highest level since 2007” is a classic sentence.
As a reader, two signals are useful. First, the pace: if volume doubles within a few quarters, caution is warranted. Second, the quality of the underlying loans. If lenders suddenly accept borrowers they would have rejected two years earlier, the wave is in its late stage.
The securitization wave before 2007 ended in the global financial crisis and cost millions of people their jobs. Since then, stricter rules have been introduced, such as the requirement to retain a portion of the risk. Whether these rules are sufficient will only become clear in the next downturn – which is why the current wave surrounding AI infrastructure is being closely watched by regulators.