One of the causes that have resulted to the global economic crisis in the last decade has been the issue of mortgage securitization. A good example is the Florida mortgages. Most retirees from Norway were involved in securing mortgages. Different financial links can be identified into how these individuals got involved in the mortgage securitization. Ideally, the process began with a simple home purchase, where the seller got cash from the buyer to secure ownership of the house. The homebuyer had to obtain cash by signing a mortgage loan agreement with the originator (mortgage brokers) who in turn got cash by selling the mortgage to a securitizing firm. The securitizing firms then developed new securities, which they sold to investors. Through this whole process, most of the money disappeared through the fees.
One of the reasons that caused the financial crisis was the approval of sub-prime standards by regulators. Previously, in the 1980’s to secure mortgage, an individual had to show or have an income that would be an indicator of the ability to pay the loan. Allowing nonqualified mortgages to be securitized increased the level of risk to the investors. The increase in the number of people who could get mortgages resulted to an increase in demand for homes. This would ideally have resulted to an increase in the house prices. However, the Feds decided to reduce the interest rates on mortgages after 9/11 to prevent a recession and kept these low rates for a long duration. The resulting consequence was that the home ownership became even affordable. This then resulted to the development of an artificial bubble in real estate.
Additionally, most of the homeowners chose to use an adjustable rate mortgage (ARM) payments, as opposed to a fixed rate mortgage payments, which allowed the homeowners to make low payments. The ARM option was riskier than the fixed rate option as it allowed the loan balance to increase each month. This happened since payments would be adjusted every month to reflect the current market interest rates thus a higher loan balance.
The mortgage brokers earned commission for every deal they finished regardless of the ability of the borrower to pay. Hence, to make more commissions they convinced even individuals who were not in a financial position to pay the mortgages. The regulations also did not require mortgage brokers to verify the income of the borrower. Securitizing firms were much concerned with making money rather than providing quality services. Thus, top officers of the mortgage firms pushed their subordinates who in turn pushed originators or mortgage brokers to obtain and write additional mortgages.
Securitizing firms paid rating agencies to do ratings to present false information to investors about the true risk sofa security. Securities that had high ratings increased investor confidence. Investors increased their investments in those securities thus generating additional business for the securitizing firms. Models developed to determine the value of new securities were insufficient in the sense that they did not consider most of the pertinent factors. Consequently, the models produced high ratings for the collateralized debt obligations (CDOs). The investors desire to make money was based primarily on returns and not the risk.
When homeowners defaulted on their payments, CDOs backed by the mortgages also followed suit. Mortgage backed securities prices went down. Financial institutions were largely affected, and some went bankrupt. Additionally, securitizing firms also crashed owing to them holding on to the new securities they had developed. Banks that had backed some of the mortgage-backed securities were affected and would not be able to provide credit to other banks that were also failing. With banks refusing to lend money, the construction and manufacturing sector were also affected, and people lost their jobs.
