NEW YORK — Even if you pay every bill on time, the money you dole out each month to credit card, mortgage and car loan companies is probably a bit player in the financial crisis.
That's because most asset-backed securities — investments derived from pools of debt such as your mortgage or credit card — are comprised of the payments made by consumers like you.
Federal policymakers are struggling to revive the market for those securities, which imploded in September. The Fed said this week it expects to start buying mortgage-backed securities in early January.
The question for investors and policymakers is whether the economy might be better off if some aspects of the market never return.
Here are some questions and answers about asset-backed securities.
Q: What are asset-backed securities?
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Asset-backed securities are created by banks and other financial institutions by taking one type of loan, such as credit card debts, bundling them together and slicing the monthly payments into something like a bond.
Car loans and student loans are also pooled together, split up and sold off. So are mortgages.
Investors looking for a steady return at minimal risk snapped up these securities in the early part of this decade. But when Lehman Brothers Holdings Inc. filed for bankruptcy in September, investors, spooked by uncertain risk, fled the market.
As a result, banks that had sold the securities were forced to hold them, even as prices plummeted. The falling prices meant they had to write down their assets. As the value of their assets fell, they had to hold on to their cash. That, in turn, left them with less cash to make new loans.
The result: Loans to households fell in the third quarter of 2008, according to the most recent data from the Federal Reserve. This rare drop is expected to repeat itself during the current quarter.
Q: Why did the market for these securities crater?
There are a host of reasons, but the simplest explanation is that the securities were far riskier than anyone involved in packaging them, selling them or rating them acknowledged.
One of many problems was that it was hard to rate the risks they entailed. While other slices of debt, such as corporate bonds, are rated according to the finances of the borrower, assessing the finances of thousands of homeowners is much trickier.
Because of this, credit ratings agencies relied on complex formulas they'd devised to assess the risk, but those mathematical models were built using data from strong economic times, not bad times, like these.
Another problem was that the banks that sold the securities and the agencies that rated them were paid per transaction. They profited by keeping the securitization machine humming.
Q: Who buys these securities?
A: Before the market froze, investors of every stripe bought the securities, from foreign banks to pension funds. The market came to nearly a complete halt in October. Now that the price has slid, the buyers are largely hedge funds and private equity funds that are looking for bargains.
Now there are almost no new issues, because the securities that already exist are trading so cheaply, said Adam Yarnold, a trader at Braver Stern, which sells distressed securities. In this respect, the market is running parallel to the housing market, where cheap foreclosed homes are selling, while new homes sit.
Q: What is the Federal Reserve planning to do?
A: The Fed said Tuesday it will begin buying up to $500 billion in mortgage-backed securities early next month. The central bank will buy securities guaranteed by the government-controlled home loan giants Fannie Mae, Freddie Mac and Ginnie Mae, a federal agency.
The central bank said it will buy mortgage-backed securities until the end of the second quarter of 2009.
Q: What if the market never comes back?
"Essentially, what got frozen out is all the highly leveraged speculative stuff," said Bob Eisenbeis, chief monetary economist at Cumberland Advisors, a New Jersey money manager.
"It's not all that clear that market is ever going to restart, at least not in the form that it was. ... Securitization markets will still exist, they just won't be as big."
Bringing back the market isn't essential to getting lending restarted, he said.
"Most of the problems were in the asset-backed paper, which was all this mortgage stuff that should never have been done in the first place, so why do you want to restart that?" he said.
