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Securitization's Role In Solving The Foreclosure Crisis

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The Role of Securitization
Securitization is the process through which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors. Mortgage-backed securities are a perfect example of securitization. By combining mortgages into one large pool, the issuer can divide the large pool into smaller pieces based on each individual mortgage's inherent risk of default and then sell those smaller pieces to investors. The securitization of subprime mortgages into mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) was a major contributing factor in the subprime mortgage crisis. Subprime MBS and CDOs were attractive to investors due to …show more content…

Many loans were made to borrowers who would have previously had difficulty obtaining mortgages due to below-average credit scores. Private lenders made a lot of money by pooling and selling the subprime mortgages. However, the risk of foreclosure increased with the relaxing of credit standards. Lenders and buyers incorrectly assumed that real estate values were impervious to a downturn. Private-label MBS provided a lot of the necessary capital for the subprime mortgages. Around 80% of subprime loans were made with private-label MBS in 2006. In March 2007, the value of subprime mortgages was valued at around $1.3 trillion. The mortgages issued by private lenders had greater risk since they were not backed by the government, like those from Freddie Mac and Fannie …show more content…

Adjustable-rate mortgages began to reset at higher rates, and mortgage delinquencies grew substantially. The default on subprime mortgages led to more problems. By August 2008, around 9% of all mortgages in the U.S. were in default. MBS and CDOs began to lose value with the higher default rates. Freddie Mac and Fannie Mae were seized by the government in 2008 as they began to realize substantial losses. Foreclosures and repossessions increased, with more properties being placed on the market as banks attempted to liquidate their inventories. This depressed property values even more, leading to a downward spiral for the real estate market. Some borrowers attempted short sales for their underwater mortgages, but they often found lenders difficult to work with or unwilling to

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