commoditize

What It Is

Commoditize means to homogenize a product or security.

How It Works

To be considered a commodity, an item must satisfy three conditions: It must be standardized (and for agricultural and industrial commodities, it must be in a "raw" state); it must be usable (i.e., have a shelf life) upon delivery; and its price must vary enough to justify creating a market for the item.

When a product becomes indistinguishable from similar products, it is considered commoditized. Most people understand the concept when it comes to orange juice, potatoes or other raw materials (i.e., the idea that "they're all the same.") But financial instruments can become commoditized, too. One example is mortgages. In the past, every mortgage issued could have been considered unique -- that is, the credit risk of the borrowers, the value of the real estate, and even the terms involved might have been very specialized. However, Federal National Mortgage Association (Fannie Mae), the Federal National Mortgage Association (Freddie Mac), and other agencies have helped commoditize mortgages because they buy them from lenders and use them to create mortgage-backed securities (which they then sell to the public). Their act of creating a market for mortgages has encouraged banks to streamline and conform the types of mortgages they offer in order to then sell those mortgages to Fannie Mae, Freddie Mac, etc.

Why It Matters

When we commoditize a security, we make it easier to trade and thus more liquid. In some cases, this can add volatility to the price of the commoditized entity, and in other cases it can spur economic activity. In the case of the mortgage industry, commoditization allows lenders to receive cash from selling their mortgages, use that cash to issue more loans, and therefore spur economic growth through more home purchases.

Source: Investing Answers

What It Is

Commoditization refers to a good or service becoming indistinguishable from similar products.

How It Works

An item should satisfy 3 conditions to be considered a commodity: 1) it must be standardized and, for agricultural and industrial commodities, in a "raw" state; 2) it must be usable upon delivery; and 3) its price must vary enough to justify creating a market for it.

Most people understand commoditization when it comes to corn, soybeans, cotton, or other raw materials (i.e., the idea that "it's all the same."). But financial instruments can be commoditized, too.

For example, in the past, every mortgage issued was considered unique -- that is, the terms and conditions of the loans were specialized according to the borrower and the property. But over time, the Federal National Mortgage Association (Fannie Mae), and the Government National Mortgage Association (Ginnie Mae) commoditized mortgages by offering to buy almost any mortgage that met a set of conforming standards. By creating a massive market for mortgages, these agencies encouraged banks to streamline and standardize the types of mortgages they offer to consumers.

Why It Matters

Commoditization makes an asset easier to trade and encourages a more liquid market. In some cases, this can add volatility to the price of the commoditized entity, but in other cases it can spur economic activity.

In the case of the mortgage industry, commoditization allows lenders to receive cash from selling conforming mortgages to government agencies and government-sponsored entities. The banks can then use the cash to issue more loans, theoretically spurring economic growth.

Source: Investing Answers