Mortgage Backed Securities and their role in the economic crisis Essay

Mortgage Backed Securities and their role in the economic crisis - Essay Example This will normally lead to a fall in the countries’ GDP, a rising and falling of prices because of inflation and deflation and a drying up of liquidity. It normally can take a form of recession or a depression. The economic crisis began with bursting of the united states housing bubble and high default rates on subprime adjustable rate mortgages (ARM),and variable rate mortgages beginning around 2005 to 2006(Wall Street Journal, December 4, 2007). Prior to the crisis, the government policies and competitive pressures encouraged high risk lending practices for several years. The role of Mortgage Backed Securities in the economic crisis The financial crisis was highly felt in the market in 2008. The civil fraud charges was filed against several major credit rating agencies for their role in developing mortgage bond that helped bring about the financial crisis in 2008. The Wall Street Journal reported that the U.S.  Securities Exchange Commission (SEC) is currently looking at t he role these companies played in the crisis and exploring the possibility of holding them accountable. The crisis began to affect the financial sector in February 2007, when HSBC, the world's largest (2008) bank, wrote down its holdings of subprime-related MBS by $10.5 billion, the first major subprime related loss to be reported. During 2007, at least 100 mortgage companies either shut down, suspended operations or were sold. Top management has not escaped unscathed, as the CEOs of Merrill Lynch and Citigroup resigned within a week of each other. As the crisis deepened, more and more financial firms either merged, or announced that they were negotiating seeking merger partners. (Wall Street Journal. Online, May 2008). Credit risk arises because the borrower has the option of defaulting...This paper outlines the role of the mortgage backed securities (MBS) in the surfacing of financial crisis Mortgage backed securities are loans that are normally purchased from mortgage companies, banks and originators and then assembled into groups by a private entity, a governmental or a quasi governmental. The securities are then offered by the entity. These securities are offered through the securitization, that represents the claims on the principal and interest payments made by borrowers on their loans in the group. Most of the mortgages are offered by a U.S. Government agency known as the National Mortgage Association or government-sponsored agencies which comprises of the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association Mortgage bonds or mortgage-backed securities were secured by a mortgage on one or more assets. They are generally backed by real property or real estate holdings. The mortgage bondholder has a claim to the underlying property and can sell it off to compensate for the default if the homeowner paying their mortgage defaults. Economic crisis refer to a situation where the economy of a nation or a country undergoes a sudden downturn which is brought about by financial crisis. The financial crisis was highly felt in the market in 2008 The civil fraud charges was filed against several major credit rating agencies Credit risk arises because borrower has the option of defaulting on the loan one owes. In the real sense, lender is the one who bore the credit risk on the mortgages issued. It was made possible for lenders to sell the right to receive the payments on mortgages they issue through securitization. This led to several risks in the financial sector