Question

 

Briefly explain mortgage securitization and how it contributed to the economic crisis.

 

Answer 1

The 2008, Global Recession has been accredited to have altered the entire world in a manner that had never taken place before as the world prior to this, was not so well connected with one another. The economic crisis was indeed a result of mortgage securitization which has been explained as follows.

Whenever a bank grants a consumer or an investor loan. there always is an underlying asset as part of a secured loan. When people are unable to pay this loan, the asset is then taken over by the bank to repay the amount. Over the years, such properties accrue for banks and limit its liquidity. The bank then consolidates all of these properties and sells them in a parcel or raises capital from them together which is known as mortgage securitization.

The 2008 Global Recession resulted from banks having set the value of properties too high so as to increase the debt of the consumer and increase their earnings. For example, by inflating a house, the actual value of which was 70 thousand dollars to 100 thousand dollars, the bank was able to grant loans as high as 80 thousand to 85 thousand dollars in spite of the actual value being much lesser.  

With Securitization as explained above, such properties grew for the banks as people found it easier to give away their properties instead of paying the debt. Their properties had reduced values when compared to the debt itself and this increased the securitization for the banks but greatly reduced its liquidity.

Banks now did not have money required to give away as future loans on one hand, and on the other the asset quality declined substantially. As a result of this, investor confidence was also shaken as people did not want to place their money with banks and ultimately led to an economic collapse which was never seen before.

Post this, the government intervened and set in place strict guidelines for lending which eased the situation in the long run. It also reduced taxes and made sure that interest rates were low, so as to keep demand and unemployment in check.

However, securitization at incorrect property assessment rates, was the core reason for the recession which shook the world in 2008.