Question

1. What is securitization and what role did it play in the subprime loan mortgage market
2. What exactly caused the subprime market to crash
3. How did the government help after the crash
4. How did the subprime market crash affect the normal market for housing
5. Do you think the subprime loan mortgage program was a good idea and why

Answer 1

The process of designing a marketable financial instrument by the act of pooling or merging different financial assets in one and selling them to investors is known as Securitisation. They are kinf of regrouped assets. This helps in freeing capital for the originators and provides opportunities to investors thus collectively promoting marketplace liquidity.

The mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) were tools of securitisation of subprime mortgages.

Invetsors found CDOs and MBS attractive as they offered higher interest rates as opposed to prime mortgage backed assets. Due to increased default risk, higher interst credit was offered. These MBS and CDOs got high credit ratings thus increasing investor confidence in them. Sub-prime lending increased the availability of credit in market, even to those who were not entitled to it before due to their financial health. This gave a boost to the real estate market. With more and more buyers in the market using loans.

The problem arose when these buyers defaulted on their payments on subprime mortgages. 9% of all US mortgages stood in default by 2008, Augusr. Amidst this, The MBS and CDOs lost their value leading to Financial Crisis.

The US government post the crisis offered bailouts to those hit by the crisis,  government housing agencies, banks, individual home owners, automobile manufacturers,etc to cope with their loss in the form of bail outs. The federal reserve, Treasury and Federal Deposit Insurance Corp. (FDIC) were the ones offering bailouts.

Post the crisis, the average housing price fell by 30%. Faced by depression, inflation and huge unemployment. Private residential investment fell tremendously. Same happened with Non-residential investment but recovered back to its peak in 2013.

Although the idea of securitisation could have been beneficial, but due to overexploitation of the security and the greed, the unchecked activities went on in an unprecedentedly high manner. Proper regullations were required at the time and more awareness amongst the investors.