Question

Describe the process of securitization as it is employed in the mortgage market. Explain how this process contributed to the financial crisis of 2008-09. Explain why mortgage rates rise and fall in response to changes in Treasury yields.

Answer 1

Securitization is a process of pooling of various kinds of contractual obligations like mortgages and selling the cash flows to the third party investors as floating securities which can be collateral debt obligations in case of mortgages.

So, the process of securitisation will be helping in providing liquidity into the entire system by selling out all these debt obligations which are backed by collaterals, so that investors investing into the securities are also secured about the security of those assets and they are trying to purchase this collateralized debt obligations in order to invest into the real estate market and they are trying to gain through the appreciation of the real estate prices.

The process of securitisation contributed to the financial crisis of 2008-09 because it was trying to infuse a lot of liquidity into the system and many type of investment banks as well as insurance companies Who were also exposed to these kind of securities because they were thought of being as secured securities as they were backed by Assets of real estate sector so they are presumably thought of being secured by the housing assets and the market believed that housing prices cannot depreciate even in a cycle of recession but when there was an excess reliability on the the quality of bad assets which have been floated through collateralized debt obligations by pooling of bad loans then it led to a series of defaults because of fall in the housing prices which was the ultimate underlying security of these bonds and it led to the overall contagion in the market and ultimately financial collapse because of faultering of many organisations.

Mortgage rates are rising and falling In response to treasury bills because they are trying to re-adjust themselves and realign themselves in order to current market rate of interest so they are trying to match the prevalent market rate of interest and they are trying to be flexible in nature so the mortgage rate are rising.