How did Mortgage-backed Securities Bring down the U.S. Economy?

And with less cash flowing in, surviving banks still would have tightened credit. Since MBSs were purchased and sold as investments, defaulted mortgages turned up in all corners of the market. The change in performance of MBSs took place rapidly, and as a result, most of the biggest institutions were laden with the securities when they went south. But the presence of MBSs created an even more pronounced effect on the U.S.

A homeowner with an ARM could find the monthly payments doubling after the rates adjusted. And since the riskiest (and highest returning) CDOs were comprised of subprime mortgages, they became worthless after the nationwide increase in loan defaults began. When the slew of ARMs that had been issued in a frenzy early on began to reset, the rate of foreclosures began to rise. When borrowers stopped making payments on their mortgages, MBSs began to perform poorly.

Some homeowners found themselves in the precarious state of being upside-down in their payments; they owed more than their homes were worth. Home builders and lenders going belly-up still would have increased unemployment. Simply walking away from the houses they couldn’t afford became an increasingly attractive option, and foreclosures increased even more. Had a situation like this taken place before the advent of mortgage-backed securities, it still would have created a ripple effect on the national economy. Foreclosures still would have deflated housing prices.

Other derivatives repay investors at a fixed interest rate, so investors lose out when interest rates rise since they aren’t making any money off the increase. Subprime mortgage-backed securities, comprised entirely from pools of loans made to subprime borrowers, were riskier, but they also offered higher dividends: Subprime borrowers are saddled with higher interest rates to offset the increased risk they pose. These loans maintain a discounted (and usually affordable) fixed interest rate for a set number of years and then adjust to a higher rate. A large amount of the mortgages taken out by subprime borrowers were hybrid adjustable rate mortgages (ARMs).

The portfolios of huge investment banks, lousy with mortgage-backed securities, found their net worth sink as the MBSs began to lose value. The giant investment bank’s worth sank enough that it was purchased in March 2008 by competitor JPMorgan for $2 per share. This was the case with Bear Stearns. Because mortgage-backed securities were so prevalent in the market, it wasn’t immediately clear how widespread the problem from the subprime mortgage fallout would be. During 2008, a new write-down of billions of dollars on one institution or another’s balance sheet made headlines daily and weekly. Fannie Mae and Freddie Mac are an example of how every part of the economy is related. Both are so entrenched in the U.S.

Can people still purchase mortgage-backed securities? Mortgage-backed securities are secured via a single mortgage or a bundle of mortgages. Can the government control a stock market crash? These are then purchased by individuals who package loans together into securities for investors to buy. Why does the Fed change the interest rate? When were mortgage-backed securities introduced? Yes, they can be bought through banks and/or brokers that follow a similar fee schedule as do other bonds. What are mortgage-backed securities?