Mortgage-Backed Securities

Definition

Mortgage-backed securities are financial instruments backed by a pool of residential or commercial mortgages. They are created by government agencies, government-sponsored enterprises, or private institutions to provide liquidity in the mortgage market and transfer risk from lenders to investors.

5 Must Know Facts For Your Next Test

1. Mortgage-backed securities were a key component of the Great Deregulation Experiment, as they allowed for the expansion of credit and increased homeownership rates.
2. The growth of the mortgage-backed securities market was fueled by the deregulation of the financial industry, which led to increased risk-taking and the development of complex financial instruments.
3. The securitization of subprime mortgages, which were often bundled into mortgage-backed securities, contributed to the housing bubble and the subsequent financial crisis of 2007-2008.
4. The collapse of the mortgage-backed securities market was a major trigger of the Great Recession, as it led to widespread losses for investors and disrupted the flow of credit in the economy.
5. The government's response to the financial crisis included efforts to stabilize the mortgage-backed securities market, such as the Federal Reserve's purchase of these securities to support the housing market.

Review Questions

• Explain how the growth of the mortgage-backed securities market was related to the Great Deregulation Experiment.
  • The Great Deregulation Experiment, which involved the loosening of financial regulations, enabled the rapid expansion of the mortgage-backed securities market. This allowed lenders to originate more mortgages and transfer the risk to investors through securitization, leading to a significant increase in the availability of credit and homeownership rates. However, the securitization of subprime mortgages, which were often bundled into mortgage-backed securities, ultimately contributed to the housing bubble and the subsequent financial crisis.
• Describe the role of mortgage-backed securities in the financial crisis of 2007-2008.
  • Mortgage-backed securities played a central role in the financial crisis of 2007-2008. The securitization of subprime mortgages, which were often included in these financial instruments, led to the creation of complex and opaque products that were difficult to value. When the housing market began to decline, the value of mortgage-backed securities plummeted, causing widespread losses for investors and disrupting the flow of credit in the economy. The collapse of the mortgage-backed securities market was a major trigger of the Great Recession, as it contributed to the broader financial instability and economic downturn.
• Analyze the government's response to the financial crisis in relation to the mortgage-backed securities market.
  • In response to the financial crisis, the government implemented various measures to stabilize the mortgage-backed securities market. This included the Federal Reserve's purchase of these securities to support the housing market and provide liquidity. Additionally, the government introduced regulatory reforms, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, which aimed to increase transparency and oversight in the securitization process. These actions were intended to restore confidence in the mortgage-backed securities market and mitigate the risk of similar crises in the future, highlighting the importance of effective regulation and government intervention in addressing systemic financial risks.

Related terms

Securitization: The process of converting assets, such as mortgages, into tradable securities that can be sold to investors.

Collateralized Debt Obligation (CDO): A type of structured finance product that is backed by a pool of debt instruments, including mortgage-backed securities.

Subprime Mortgage: A mortgage loan granted to borrowers with poor credit histories or low income, often with higher interest rates and less favorable terms.