What is the Mortgage Meltdown?

During the last few years, the subprime mortgage market has experienced a decline. This has impacted the overall economy. It has also affected homebuyers’ pursuit of owning a home.

Investment banks

During the housing bubble, investment banks bundled mortgages into a product called a mortgage-backed security. These securities were designed to generate fees for firms. The MBS market worked well for a while. But, when default rates on subprime mortgages began to rise, the bottom-of-the-barrel tranches of the MBSs were wiped out. When mortgage-backed securities began to fail, major financial institutions were in dire need of capital. They borrowed vast amounts of money at low rates, and their lending capabilities slowed. These institutions then turned to the overnight lending market for short-term financing. These overnight lenders offer short-term loans in exchange for collateral. If the collateral is lost, the lender pulls back the funding. This caused a freezing of the credit markets. The financial crisis reshaped the world of finance. In particular, the shadow banking system became a major player. This is when non-bank financial institutions such as hedge funds take on increasingly prominent roles in lending money. As a reporter on the money beat, one of Landon Thomas Jr.’s interests was in hedge funds. The US government also stepped in to bail out major financial institutions like Bear Stearns. The government also bailed out Fannie Mae and Freddie Mac.

Homebuyers’ pursuit of owning a home

Purchasing a home is an essential step for many Americans. But buying a house can be challenging to do. Often, people must get a mortgage to buy their dream home. Homeowners struggling to pay their mortgages often face the prospect of being forced to foreclose. Foreclosures grew to a record high during the last half of 2006. In addition to foreclosures, home prices have also dropped. The subprime mortgage crisis was a result of borrowers getting into risky mortgages. This grew out of overly aggressive mortgage lending and a weakened economy. Some homeowners also used the money they saved on their mortgages for living expenses. Several homeowners avoided foreclosure, but many found themselves in unaffordable homes. This created a dilemma. They had to decide whether they could wait for the bank to foreclose or renegotiate their loan. In 2007, the mortgage market took a turn for the worse. Home prices fell, and dozens of mortgage lenders declared bankruptcy. This created panic in the real estate market. Then, interest rates started to rise, making it harder for buyers to get a mortgage.

Lehman Brothers

Among the many historical factors that have been compared to the Lehman Brothers mortgage meltdown, the fact that the US economy was amid a historic high of subprime loan defaults is one that has loomed large. Other factors may have played a part as well. Lehman’s failure was mainly due to the company’s overzealous risk-taking in the housing market. Its subprime lending business was generating the riskiest loans to low-income consumers. These loans were risky due to the borrowers’ lack of ability to pay off their loans. As a result, the value of the CDOs based on these loans began to decrease. A client demanded where his bonds were. The insurance on these mortgages offset the value of the mortgages.

Government bailouts

During the Global Financial Crisis, the federal government invested nearly eight trillion dollars in bailing out crippled banks. These big banks were once seen as the central drivers of the economy. But once the Lehman Brothers collapsed, these banks lost their power in the legislative process.  The government could bail out undercapitalized loan servicers, but that would be costly for the American people. It would also put a brake on the housing industry. If loan servicers were left to fail, homeowners would not be able to refinance their existing loans. That would also destroy the secondary market for home loans.