2008 Financial Crisis 5page Term Paper
CrIsaac Mendez 951218667 The 2008 US Financial Crisis & The Aftermath
The Core Driver of the Crisis : Asset Backed Securities Banks make money through giving out loans to consumers. Home loans are one of the most common type of loan a bank provides customers and its very profitable. However, banks needed a form of collateral when it lends individuals a large sum of money to purchase a home. So if a borrower were to default on their loan, the bank can cover the lost by gaining possession of the house and selling it in the market [1]. However in 1960s, banks could not keep pace with this funding and this led to the development of the mortgage-backed securities (MBS) market [2]. In essence, mortgages were pooled and given to Fanny Mae and Freddie Mac. Fanny Mae and Freddie Mac would securitized the mortgages given to them and sell it as mortgage-backed securities which can be traded in the financial system. This act of pooling the mortgages is called securitization and the name of instruments sold is called mortgage backed securities(MBS). Mortgage backed securities are very profitable to banks because they get a fee for originating the mortgages and passing them to Fannie Mae and Freddie without having to worry about the mortgage anymore. MBS at the time before crisis was widely traded at the time and some companies kept a significant number of it in their portfolios which will become a problem during the financial crisis.
The Financial Crisis After the stock market crash in 2001, recession took place in the US which led to interest rates to be as low as 1% in 2003, the lowest in 30 years [1]. The Fed also signaled that the interest rates were to remain low for an extended amount of time. As a result, the demand for housing increased substantially which led to a problem of uneven supply and demand. Banks took advantage of this demand to make money. They did this by relaxing their lending standards to “risky” customers and this action is called
The Core Driver of the Crisis : Asset Backed Securities Banks make money through giving out loans to consumers. Home loans are one of the most common type of loan a bank provides customers and its very profitable. However, banks needed a form of collateral when it lends individuals a large sum of money to purchase a home. So if a borrower were to default on their loan, the bank can cover the lost by gaining possession of the house and selling it in the market [1]. However in 1960s, banks could not keep pace with this funding and this led to the development of the mortgage-backed securities (MBS) market [2]. In essence, mortgages were pooled and given to Fanny Mae and Freddie Mac. Fanny Mae and Freddie Mac would securitized the mortgages given to them and sell it as mortgage-backed securities which can be traded in the financial system. This act of pooling the mortgages is called securitization and the name of instruments sold is called mortgage backed securities(MBS). Mortgage backed securities are very profitable to banks because they get a fee for originating the mortgages and passing them to Fannie Mae and Freddie without having to worry about the mortgage anymore. MBS at the time before crisis was widely traded at the time and some companies kept a significant number of it in their portfolios which will become a problem during the financial crisis.
The Financial Crisis After the stock market crash in 2001, recession took place in the US which led to interest rates to be as low as 1% in 2003, the lowest in 30 years [1]. The Fed also signaled that the interest rates were to remain low for an extended amount of time. As a result, the demand for housing increased substantially which led to a problem of uneven supply and demand. Banks took advantage of this demand to make money. They did this by relaxing their lending standards to “risky” customers and this action is called