Securitization is not 'evil', neither is short-selling, nor CDS

A recent paper, Securitization of Mortgage Debt, Asset Prices and International Risk Sharing (CESifo Working Paper No. 2527, downloadable here) provides a refreshingly calm and measured assessment of the effects of mortgages securitization on the markets stability via allowing for greater international diversification of macroeconomic risk. According to the authors, "by making mortgage-related risks internationally tradeable, securitization contributes considerably to better international consumption risk sharing: we find that countries with the most highly developed markets for securitized mortgage debt have consumption responses to a typical idiosyncratic business cycle shock that are 20-30 percent less (my emphasis throughout) volatile than those experienced by countries that do not allow for mortgage securitization. Our results are based on quarterly data from a panel of 16 industrialized countries and cover the sample period 1985-2008Q1. They are robust to a range of controls for other aspects of financial globalization, international differences in the structure of housing markets and the financial system etc. Against the backdrop of the subprime crisis, these findings inevitably raise the question whether securitization could not just facilitate risk sharing in tranquil times but that it actually fails to provide international insurance in severe crisis periods. Indeed, we find that international risk sharing decreases in global asset price downturns and increases in booms. But we do not find evidence that countries with more developed securitization markets are systematically more exposed to these fluctuations in the extent to which risk can be shared across national boundaries."

Funny thing - there is now growing academic literature on the positive effects of such 'evil' forms of fiance as short-selling. See for example here and here (arguing that short-selling is superior to put options and even analysts in predicting negative returns), here, here and here (suggesting that short-selling adds to price efficiency in the case of dividend manipulation), here (arguing that share prices adjust to their fundamentals-justified equilibrium faster when short-selling is less restricted), and here (indicating that bans or restrictions on short-selling can have destabilising effects on even such 'stable' markets as those for government bonds).

While many more papers are available on the subject, what is apparent from the recent events is that politically motivated regulatory interventions in financial markets are exactly what they say they are - politically motivated changes that have little do with markets stability or efficiency. This is precisely why we should actively resist the current political push for restricting securitization, just as we should resist the push for banning short-selling or speculation.

Update: ... and CDS are not bad either... see comprehensive discussion on CDS here. Obviously all evidence flies in the face of our quasi-literate (economically speaking) DofF boffins (recall my post here).