Question

3) CMO’s (collateralized mortgage obligation) is a form of securitization. How did these products lead to a positive growth in the housing market?

Answer 1

Securitization is a process used by banks to create securities from loans and other income-producing assets.The first loans to be securitized were mortgages in the US. Investors who bought the mortgage backed securities were not exposed to the risk of borrowers defaulting because the loans were backed by the Government National Mortgage Association.Tranches were created from subprime mortgages and new tranches were then created from these tranches.The US government was keen to encourage home ownership. Interest rates were low. Mortgage brokers and mortgage lenders found it attractive to do more business by relaxing their lending standards. Securitization meant that the investors bearing the credit risk were not usually the same as the original lenders. Rating agencies gave AAA rating to the senior tranches that were created. There was no shortage of buyers for these AAA-rated tranches because their yields were higher than the yields on other AAA-rated securities. House prices rose as both first time buyers and speculators entered the market.