paper about MBS

Nevertheless it did not help that the worst financial

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Unformatted text preview: Nevertheless, it did not help that the worst financial and economic crisis in the United States since the Great Depression was preceded by a real estate boom of historic proportions. Households could get more debt than ever before by borrowing against the ever-increasing value of their homes. Mortgage lenders were in a race to the bottom in terms of the quality of the loans that they issued. This slippage of credit standards was in part because it had become commonplace for them to pass on the mortgage loans to others in the form of MBS and collateralized debt obligations (CDOs). Large, complex financial institutions had found ways to hold securitized assets on their balance-sheets with little capital backing them. Checks and balances down the securitization chain thus weakened. This allowed subprime mortgage lenders to pursue aggressive lending practices. A subtle effect of the subprime lending boom was that the share of higher quality – “conforming” – mortgages fell. As described in Chapter 3, the GSEs gradually lost market share in the MBS market. To keep up profits for their shareholders, they started buying ever more risky mortgages in the years 2003 to 2007. The quality of their portfolio was not helped by Congress’ mandate for Fannie and Freddie to buy an ever higher proportion of mortgages from low-income households and underserved areas. Not long after house prices peaked in the summer of 2006, the first subprime mortgage lenders started to go belly-up. Bear Stearns’ hedge funds collapsed in June 2007, primarily due 63 to problems in their mortgage portfolio. In 2007, Freddie and Fannie’s gigantic portfolio of loans incurred $8 billion in credit losses, and the GSEs turned their first annual loss after fifteen years of record profits. These credit losses spiraled out of control in the second half of 2008. Because the GSEs were so highly levered, any credit losses had a dramatic impact on their solvency. On September 7, 2008, the GSEs were placed in the government’s conservatorship. As of the late summer of 2010, the GSEs have used up $145 billion from their initial $200 billion government lifeline, with analysts projecting at least another couple of hundred billions to fill the hole of their credit losses from their misguided mortgage investments of 2007 and earlier. This bailout will have the largest net costs (outlays minus recoveries) of all of the government’s bailout efforts, far exceeding the cost of the AIG bailout or the TARP program. The GSE bailout represents the creation of a “bad” bank for mortgage-related losses in the United States. Through the conservatorship, the government has kept the mortgage market afloat in 2009 and 2010, and it has used the GSEs as a tool for mortgage modifications. This chapter relives the collapse in slow motion....
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Nevertheless it did not help that the worst financial and...

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