Asset-backed securities (ABS) are created by the repackaging (securitization) of loans (or predicted future revenues) into new financial products that can be resold to investors. Income from these securities is supported by the stream of expected revenues that the assets bundled together in this way are expected to generate in future. The most typical case is the mortgage-backed securities that played a major part in the 2008 financial crisis, although anything from credit card repayments to musicians’ royalties have been sold in the same way. The main common features are the repackaging itself, and their re-sale by companies set up exclusively for this purpose (special purpose vehicles, SPVs).
Asset-backed securities bundle together small debts into larger products that can be re-sold to investors. Pooling debt in this way in theory makes it safer, since any one of the underlying assets can be defaulted on without risking the whole package. In practice, it makes the whole system more risky, because the complex web of repackaged debts makes it impossible to truly assess the value of the underlying assets, and creates a long and obscure paper trail even to find what they are. This did not stop financial markets from creating and selling more and more asset-backed securities, which began to resemble a giant Ponzi scheme. These products were particularly attractive to banks, who set up SPVs and created asset-backed securities to get debt off their books, as a means of circumventing the capital requirements laid down by the Basel Accords.
Asset-backed securities are often traded in the form of Collateralized Debt Obligations (CDOs), which add a further layer of complication by repackaging the debt into tranches with various supposed levels of risk.
Proposals for the creation of climate bonds or forest bonds often suggest that they could take the form of asset-backed securities.