October 05, 2008

(what are) Mortgage-Backed Securities and how they brought down the economy

Mortgage-Backed Securitieare a type of asset-backed security that is secured by a mortgage, or a collection of mortgages. These securities must also be grouped in one of the top two ratings as determined by a accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. Furthermore, the mortgage must have originated from a regulated and authorized financial institution.

Also known as a mortgage related security, or a mortgage pass-through.

Investopedia Says:
When you invest in a mortgage-backed security you are in lending money to a home-buyer or business. An MBS is a way for a smaller regional bank to lend mortgages to its customers without having to worry if the customers have the assets to cover the loan. Instead, the bank acts as a middleman between the home-buyer and the investment markets. --------------> More

How the Mortgage-Backed Security Brought Down the Economy

When the foreclosure rate began to increase late in 2006, it also released more new homes on the market. New home construction had already outpaced demand, and when large numbers of foreclosures became available at deeply discounted prices, builders found that they couldn't sell the homes they'd built. Richard Dugas, CEO of Pulte Homes, a building company, said in September 2008, "We can't afford to compete with foreclosures at 40 percent to 50 percent off" [source: Builder].

The presence of more homes on the market brought down housing prices. Some homeowners found themselves in the precarious state of being upside-down in their payments; they owed more than their homes were worth. 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. Home builders and lenders going belly-up still would have increased unemployment. Foreclosures still would have deflated housing prices. And with less cash flowing in, surviving banks still would have tightened credit. But the presence of MBSs created an even more pronounced effect on the U.S. economy.----------------> More

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