Skip to main content

How Mortgage-Backed Securities Caused the 2008 Financial Crisis and What We Can Learn from It



Mortgage-Backed Securities (MBS) Explained in One Minute: Did We Learn Our Lesson?

Mortgage-backed securities, or MBS, are bonds that are backed by a pool of mortgages, usually residential ones. They are created by banks and other financial institutions that originate and service the mortgages, and then sell them to investors who receive the interest and principal payments from the borrowers1

MBS are attractive to investors because they offer higher returns than other fixed-income securities, such as government bonds or corporate bonds. They also diversify the risk of default, since a single borrower’s failure to pay does not affect the entire pool of mortgages2

However, MBS also have some drawbacks and risks. One of them is the uncertainty of the cash flows, since borrowers can prepay or refinance their mortgages at any time, reducing the expected maturity and yield of the MBS. Another risk is the credit risk, which is the possibility that borrowers will default on their mortgages, especially if the value of their homes falls below the amount they owe3

This risk became evident during the 2007-2008 financial crisis, which was triggered by the collapse of the US housing market and the subprime mortgage sector. Subprime mortgages are loans made to borrowers with low credit scores or income, who are more likely to default or become delinquent. These mortgages were often securitized into MBS and sold to investors who were unaware of the true quality and risk of the underlying loans4

When the housing bubble burst, many borrowers defaulted on their mortgages, causing the value of the MBS to plummet. Many financial institutions that held or traded MBS suffered huge losses and faced liquidity problems, as the market for these securities dried up. Some of them, such as Lehman Brothers, went bankrupt, while others had to be bailed out by the government or merged with other firms. The crisis spread to the global financial system and the real economy, resulting in the worst recession since the Great Depression5

The financial crisis exposed the flaws and failures of the MBS market, such as the lack of transparency, regulation, and oversight, the misalignment of incentives and interests, and the excessive leverage and risk-taking. It also revealed the need for reforms and changes in the financial system, such as the Dodd-Frank Act in the US, which aimed to prevent another crisis by imposing stricter rules and standards on the MBS and other financial products and institutions6

MBS are still a major part of the global financial market, as they provide funding and liquidity for the housing sector and offer opportunities and challenges for investors. However, they also carry lessons and warnings from the past, and require careful analysis and evaluation before investing in them.

Comments

Post a Comment

Popular posts from this blog

Book Review: Atomic Habits: An Easy & Proven Way to Build Good Habits & Break Bad Ones by James Clear

  Atomic Habits by James Clear is an absolute game-changer for anyone looking to build good habits and break bad ones. This book has truly revolutionized the way I think about habits and how they impact our lives. Clear's writing is easy to follow and understand, and he provides practical and actionable steps to help you create the habits you want in your life. One of the things I loved most about this book was the emphasis on making small, incremental changes. Clear explains how small changes over time can lead to big results, and how even the smallest of habits can have a profound impact on our lives. This idea was incredibly empowering to me, as it means that anyone can make a change in their life, no matter how small it may seem. Another aspect of the book that I found incredibly helpful was Clear's focus on the systems and processes that drive our habits. By understanding the underlying systems and processes, we can more easily create new habits and break old ones. Clear p...
Post a Comment
Read more

How Social Media Impacts Your Finances: The Good, The Bad, and The Ugly

  The Economics of Social Media: How It Affects Your Wallet Social media platforms, such as Facebook, Twitter, Instagram, and TikTok, have become ubiquitous in the modern economy and fundamentally changed how people interact, communicate, and consume information. But what are the economic implications of social media for individuals, businesses, and society? How does social media affect your wallet, both positively and negatively? In this blog post, we will explore some of the main aspects of the economics of social media, based on the latest research and evidence. The Production of User-Generated Content One of the distinctive features of social media platforms is that they rely on user-generated content (UGC), which is any form of content, such as text, images, videos, or audio, that is created and shared by users. UGC is the main source of value for social media platforms, as it attracts and retains users, generates data, and enables targeted advertising. However, UGC also poses...
Post a Comment
Read more

How to Spot and Avoid Spoofing in Crypto: A Guide to Order Books and Market Manipulation

Order Books and Spoofing (Crypto’s “Spoofy”) Explained in One Minute: Definition, Legal Issues, etc. If you are a crypto trader, you may have heard of terms like order books and spoofing. But what do they mean and how do they affect the market? In this post, we will explain these concepts in one minute and help you understand the risks and opportunities they present. What Are Order Books? Order books are simply records of all the buy and sell orders that are placed on a crypto exchange for a specific asset. They show the price and quantity of each order, as well as the time and date they were placed. Order books are useful for traders because they provide information about the supply and demand of the market, as well as the liquidity and volatility of the asset. For example, if you want to buy Bitcoin, you can look at the order book and see how many sellers are willing to sell at different prices. You can also see how many buyers are competing with you for the same asset. This can help...
Post a Comment
Read more