Are There Too Many Safe Securities? Securitization and the Incentives for Information Production

Samuel G. Hanson; Adi   Sunderam

Article | Journal of Financial Economics | June 2013

Are There Too Many Safe Securities? Securitization and the Incentives for Information Production

Abstract

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 endogenous scarcity of informed investors exacerbates primary 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.

Keywords: Information; Debt Securities; Financial Crisis;

Format: Print

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Citation:

Hanson, Samuel G., and Adi Sunderam. "Are There Too Many Safe Securities? Securitization and the Incentives for Information Production." Journal of Financial Economics 108, no. 3 (June 2013): 565–584. (Internet Appendix Here.)

Using historical data on post-war financial crises around the world, we show that crises are substantially predictable. The combination of rapid credit and asset price growth over the prior three years, whether in the nonfinancial business or the household sector, is associated with about a 40% probability of entering a financial crisis within the next three years. This compares with a roughly 7% probability in normal times, when neither credit nor asset price growth has been elevated. Our evidence cuts against the view that financial crises are unpredictable “bolts from the sky” and points toward the Kindleberger-Minsky view that crises are the byproduct of predictable, boom-bust credit cycles. The predictability we document favors macro-financial policies that “lean against the wind” of credit market booms.

Drawing on lessons from the 2007–2009 Global Financial Crisis (GFC) and a simple conceptual framework, we examine the response of U.S. bank regulators to the COVID-19 pandemic. We argue that the current regulatory strategy of “watchful waiting”—the same strategy that was used during the early stages of the GFC—poses unnecessary risks to the financial system and broader U.S. economy. Instead, promoting an early recapitalization of the banking system, by stopping dividends and by encouraging new equity issues, would be a more prudent way to manage the vulnerabilities the pandemic has created. We close by suggesting additional measures that we believe regulators should take in both the short and long run.

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Are There Too Many Safe Securities? Securitization and the Incentives for Information Production

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