Question

add a detailed description of mortgage-backed securities in the context of the Global Financial Crisis, which includes:

1. A detailed and specific outline of mortgage-backed securities themselves,
2. an explanation of why they can be useful financial instruments,
3. an explanation of the role they played in the Global Financial Crisis, and
4. a comparison between 2) and 3), explaining why the potential benefits and uses of mortgage-backed securities did not manifest in the Global Financial Crisis.

Answer 1

Description of mortgage-backed securities

A mortgage-backed security (MBS) is an investment similar to a bond that is made up of a bundle of home loans bought from the banks that issued them. Investors in MBS receive periodic payments similar to bond coupon payments. The MBS is a type of asset-backed security.

Why mortgage-backed security (MBS) can be useful financial instruments:

It allows investors to benefit from the mortgage business without ever having to buy or sell an actual home loan. Typical buyers of these securities include institutional, corporate, and individual investors.

Role mortgage-backed security (MBS played in the Global Financial Crisis:

The securitization of subprime mortgages into mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) was a major contributing factor in the subprime mortgage crisis. Subprime MBS and CDOs were attractive to investors due to the higher interest rates they offered versus assets backed by prime mortgages. Subprime borrowers with less than perfect credit had higher interest rates on their mortgages due to the increased risk of default. Further, many loans with adjustable-rate mortgages were made that later added a great deal of fuel to the mortgage crisis.

Why the potential benefits and uses of mortgage-backed securities did not manifest in the Global Financial Crisis.

The real estate market boomed, with more buyers bidding up the prices of available houses. The real estate markets in Florida, Arizona and the Las Vegas area were very hot during this time. At first, subprime borrowers who fell behind could refinance their mortgages based on higher property values or could sell homes at a profit. The amount of risk for subprime mortgages was not an issue at this time.

Only when property values began to decline did issues begin to appear. Adjustable-rate mortgages began to reset at higher rates, and mortgage delinquencies grew substantially. The default on subprime mortgages led to more problems. By August 2008, around 9% of all mortgages in the U.S. were in default. MBS and CDOs began to lose value with the higher default rates.