Securitization of assets provides banks with an opportunity to deal with their funding problems. Because of this, most banks always have an incentive to securitize their assets. When mortgages are securitized, the banks can generate instant income through the money which investors pay upfront (Brose, Flood, Krishna, & Nichols, 2014). This money can then be used for additional lending to other customers. The investors buy the expected cash flows as security. As such, any principal and interest payments that the bank receives is passed to the investors. On the other hand, the banks get principal payments upfront. This increases the bank’s liquidity position hence solving any funding challenges that the bank might have had before it converted expected cash flows into immediate income (Brose et al., 2014).

However, although securitization might seem to be a good concept to the economy, it can have devastating effects. This is clearly evident from the recent home mortgage crisis that was experienced in the United States. The subprime mortgage crisis was caused by securitization of subprime mortgages into collateralized debt obligations and mortgage-backed securities (Brose et al., 2014). At the same time, the government initiatives to have low-income earners own homes also played a large part in the crisis. Fred Mac and Fred Mae are government-sponsored entities which were in the middle of this crisis.

They bought mortgages and securitized them before bundling them for sale to investors (GECRC, 2009). As a result, many people who would have had difficulties accessing mortgages in previous periods were able to get mortgages. The assumption was that real estate prices were not likely to decline. Unfortunately, property values began to fall in 2007/2008 and the ensuing default on issued mortgages became a huge problem. As a result, Freddie Mac and Fannie Mae failed and they were taken over by the government (GECRC, 2009).

In view of the above, the practice of securitization is good when done with caution. This is because it makes it possible for banks to solve their liquidity constraints by giving them immediate cash that they can use for further lending. However, it can also give financial institutions false security, which can make them overlook certain risks and make risky assumptions, which can lead to a similar situation to the 2007/2008 home mortgage crisis (GECRC, 2009).