Are There Too Many Safe Securities? Securitization and the Incentives for Information Production
Executive Summary — Markets for near-riskless securities have suffered numerous shutdowns in the last 40 years, with the recent financial crisis the most prominent example. This suggests that instability could be a general characteristic of such markets, not just a one-time problem associated with the subprime mortgage crisis. Professors Samuel G. Hanson and Adi Sunderam argue that the infrastructure and organization of professional investors are in part determined by the menu of securities offered by originators. Since robust infrastructure is a public good to originators, it may be underprovided in the private market equilibrium. The individually rational decisions of originators may lead to an infrastructure that is overly prone to disruptions in bad times. Policies regulating originator capital structure decisions may help create a more robust infrastructure. Key concepts include:
- Financial innovations that create near-riskless securities encourage investors to rationally choose to be uninformed. Learning from prior mistakes will not necessarily eliminate the instabilities associated with near-riskless securities.
- Capital structure regulation in good times can improve welfare. Specifically, it may be desirable to regulate the capital structures of securitization trusts by limiting the amount of AAA-rated debt that can be issued in good times.
- Informed investors are a robust source of capital capable of analyzing investment opportunities and financing positive NPV (net present value) projects even in bad times.
We present a model that helps explain several past collapses of securitization markets. Originators issue too many informationally insensitive securities in good times, blunting investor incentives to become informed. The resulting scarcity of informed investors exacerbates market collapses in bad times. Inefficiency arises because informed investors are a public good from the perspective of originators. All originators benefit from the presence of additional informed investors in bad times, but each originator minimizes his reliance on costly informed capital in good times by issuing safe securities. Our model suggests regulations that limit the issuance of safe securities in good times.