The Derivatives That Sunk Banks In The Global Crisis

Mortgage-backed securities played a significant role in the Global Financial Crisis of 2008. These securities had attractive interest rates and were given next to perfect ratings by credit rating agencies such as Moodys and Standard and Poor. Large amounts of funding were put into the housing market through the mortgage backed securities and this funding became a cycle. People were looking to buy homes so mortgage companies sold mortgages to banks, which led to banks packaging the mortgages with other investments, and the mortgage-backed securities were sold to investors. The investors’ money created more money for mortgage lenders to offer. 

Since lenders were contributing funds to subprime mortgages, people who have lower credit scores, many of these homeowners began to default on their mortgage payments. In April of 2007, New Century, a U.S. Financial Mortgage Corporation, filed for bankruptcy because of poor mortgage lending decisions. Soon after, Countrywide, the largest U.S. subprime mortgage lender, filed for bankruptcy. Following these two mortgage lenders filing for bankruptcy, U.S. banks’ balance sheets decreased.

While subprime mortgages and mortgage back securities were instruments that …

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Mortgage Backed Securities: United States and Ireland

The United States government wants mortgages readily available for people in the market for a new home. In order for mortgages to be available, banks would have to have enough capital to make such loans. In effort to support banks, the United States Congress has federal mortgage organizations to monitor and support the mortgage market. Three federal mortgage organizations that exist are Fannie Mae, Freddie Mac and Ginnie Mae. While these may sound like foolish nicknames for government-created organizations, these organizations are vital for monitoring mortgage banks in the United States. If too much capital is readily available from banks to the public, these government organizations buy mortgages from banks. Upon the organizations’ purchase from the bank, the Federal National Mortgage Association (Fannie Mae), for example, can hold these mortgages until a time of need or sell securities, backed by several of these mortgages, to investors willing to invest in real estate. The capital from the investors’ mortgage-backed securities purchase allows for more loans for new homebuyers, while the investors await return through the new homebuyers’ mortgage repayments. It is …

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How Do American Mortgages Work? Part 8: Investors

The end of the line for the secondary mortgage market process is the investors themselves. Investors can be anyone but typically are foreign governments, pension funds, insurance companies, banks, GSEs and hedge funds. What kind of return are they looking for depends on what credit ranking of MBS, CMOs, or CDOs they acquire. Typically, more safe investors such as governments, pension funds, insurance companies, or banks are looking for a high credit investment. These investments have low predicted default rate. Investors looking for higher returns will more than likely look towards a low credit rating investment because the interest rate will have a higher return yield, hedge funds are usually investors of this type.

While America’s secondary market is massive, after a mortgage is closed it can end up in many different channels by the end of the month, whether it be a CMO or a CDO deal. Borrowers have little knowledge of the extent of what happens with their mortgage after closing and how much it has been split up, traded, and merged with other mortgages. With the start …

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How Do American Mortgages Work? Part 7: Securities Dealers

After a mortgage backed security (MBS) is formed, it needs to be sold to the investor. To do that, the MBS needs to go through a securities dealer. This dealer is more than likely located on Wall Street along with MBS trading desks. To better cater to the investor, a securities dealer has to go through creative and innovative channels to make the MBS look attractive to an investor. There is many different structures a MBS can go through such as Collateralized Mortgage Obligation or a Collateralized Debt Obligation.

Collateralized Mortgage Obligation (CMO) are the typical bundle of mortgages that is sold as an investment that was first issued in 1983. They are categorized from maturity and level of risk, and as the repayments of the loan comes in as a cash flow they are distributed to the investors in the set guidelines of the investment. These investments, since of the differences of the mortgages included within type or risk, interest rates, and principal balances, they can be quite sensitive to the change in the housing economic conditions and interest …

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The credit crisis visualised

This is an interesting animated film on the origins of the crisis, it holds with the view that banks were only ever a part of the problem and not necessarily the sole cause. Central banks have a lot to answer for, as does all of society because when you stop saving and instead spend somebody else’s savings it means that eventually, when it comes time to repay your loans that not only is the money not there, but the productivity has likely suffered as well – income based on lending gives the artificial appearance of wealth but it is a mirage.

part 2

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