This was originally written in terms of South African Rand, I've changed Rand into Dollars, and various British spellings for sake of clarity to American readers. I apologize for the lack of attribution, I do not know who the original author is. -AK
A Simple Explanation of Securitization
It is the simple basic task of taking a whole pile of simple single things, joining them all together and calling the collective of them all a new thing, and then selling that thing.
In the banking sector its the taking of a bunch of loans, bundling them together, calling a group of 10 loans a 'structured investment vehicle', and then selling the 'structured investment vehicle' to someone else.
In the Stock Exchange it just taking a group of separate stocks, bundling them together, calling them a unit trust, and selling a unit trust.
In the insurance industry its just taking a bunch of insurance policies, grouping them all together, calling them a re-insurance group, and selling the re-insurance group.
The underlying common principle behind every one of these acts is that the new thing that is formed is not an actual physical thing, and therefore somebody is not paying for an actual physical thing and that is where the whole monetary system collapses.
Its the whole 'widgets in your hand' story.
If you have a factory making widgets and it makes 10 widgets and sells them for $1 each, then the factory has received $10 rand and somebody else has 10 widgets. If that someone else then bunches them together into a 'box of widgets' and sells "A box of widgets" to someone else for $15, then someone else has paid $15 for 10 widgets THAT ARE ONLY WORTH $10.
If that someone else ever tries to sell one of those widgets he has to ask $1.50 for it just to break even, but no-one will ever pay him $1.50 for it because they can buy it from the widget factory for $1.00 already, so at some stage someone will always end up sitting with something that he has paid too much money for that he cannot sell to anyone. And if that someone is a bank, who said to 10 customers give me $1.50 each so that we can buy this 'box of 10 widgets' for$R15, and therefore the bank didn't use their own money, then the bank just turns round to those 10 guys and just says "sorry I've lost your money its not my problem its you who lose out, I'm alright jack because I just get paid a salary for going shopping for "boxes of widgets." And those 10 customers who gave the bank their money are left sitting with a widget each that they have paid $1.50 for that anyone else can buy at the widget factory for only $1.00.
It doesn't matter if widgets are house loans, stock shares, insurance policies, personal loans, investments, rare paintings, whatever, and they call it securitization or re-insurance or unit trusts or underwriting or whatever, as long as somebody is taking AND DOING NOTHING TO IT (Adding no value) AND CHARGING SOMEBODY ELSE MORE FOR IT, THERE WILL ALWAYS BE AN END PERSON GETTING STUCK WITH IT WHO HAS PAID TOO MUCH FOR IT AND CANT GET HIS MONEY (OR THE PEOPLES WHOSE MONEY HE IS USING) BACK.
(Of course house prices going up and down and stock fluctuations and exchange rates all play a part but the above is the basic fundamental principle)
Of course all of this must never be confused with someone buying widget A (a car engine) for $1 and widget B ( a car body) for $1 and widget C (tires glass seats etc) for $1 and putting them all together to make widget D (a fully functioning car) and selling that for $5. In that instance the person buying widget D (a fully functioning car) IS GETTING SOMETHING THAT DIDN'T EXIST BEFORE so therefore its right to pay more for something that didn't exist before.
But with Securitization etc, THEY ARE NOT MAKING SOMETHING THAT DIDN'T EXIST BEFORE. There is no more widgets than there were before, there are no more houses than there were before, there are no more signed loan agreements than there were before, there is no more stocks or shares than there were before, there is nothing more than what was just there originally but somebody is paying more for just exactly what was there before, and that is where the system will always fall apart.
Its exactly the same as interest.
It sits in the bank
The bank lends 10 people $10 each
Still only $100 exists.
each person has to pay back $11 to the bank
They can't, $110 doesn't exist, it cannot be done.
They will keep paying until they have each paid $10 and then they are stuck, another $1 each DOES NOT EXIST to pay back.
So then the whole system will collapse.
That is a very simplified version and the borrowing goes on and on for decades before it all falls apart but the basic principle is the same.*
*AK Note: this is also why under our current economic system there will always be losers, poverty, and unemployment, its a direct result of a system that by nature is not sustainable, since the banking system creates no real new net value, it only extracts value.