Asset-backed security

In finance, an asset-backed security is a type of debt security that is based on pools of assets, or collateralized by the cash flows from a specified pool of underlying assets. Assets are pooled to make otherwise minor and uneconomical investments worthwhile, while also reducing risk by diversifying the underlying assets. Securitization makes these assets available for investment to a broader set of investors. These asset pools can be made of any type of receivable from the common, like credit card payments, auto loans, and mortgages, to esoteric cash flows such as aircraft leases, royalty payments and movie revenues. Typically, the securitized assets might be highly illiquid and private in nature.

In some cases it can be used as credit enhancement by creating a security that has a higher rating than the issuing company which monetizes its assets. This allows it to pay a lower rate of interest than would be possible via a secured bank loan or debt issuance.

With the onset of the credit crisis of 2007-2008, it is now understood that asset backed securities are extremely high risk for investors. The fundamental issue is that the structure of the security permits loan originators to collect fees from originating loans without regard to the creditworthiness of the borrower, since they retain no liability for bad loans. This feature of asset backed securities was directly responsible for the credit bubble of the mid-2000s as well as the credit crisis and the financial and economic crisis of 2007-2008.