Briefly, explain mortgage securitization and how it contributed to the economic crisis.
Homeowners wanted better homes than they could afford. Mortgage brokers encouraged homeowners to take mortgages that would reset to payments that the borrowers might not be able to pay because the brokers got a commission for closing the deal. Appraisers thought the real estate boom would continue and over-appraised house values, getting paid at the time of the appraisal. Originating institutions (like Countrywide) sells the mortgages to investment banks and other agencies. Investment banks created CDOs and got rating agencies to help design and then rate the new CDOs, with rating agencies making big profits despite conflicts of interest. Financial engineers used unrealistic inputs to generate high values for the CDOs. Investment banks sold the CDOs to investors and made big profits. Investors bought the CDOs but either didn’t understand or care about the risk. Some investors bought “insurance” via credit default swaps.
When Current mortgages reset and borrowers defaulted, the values of CDOs will plummet and credit default swaps failed to provide insurance because the counterparty failed. Many originators and securitizers still owned subprime securities, which led to many bankruptcies, government takeovers, and fire sales, including New Century, Countrywide, IndyMac, Northern Rock, Fannie Mae, Freddie Mac, Bear Stearns, Lehman Brothers, and Merrill Lynch.
4-5 paragraphs in APA style scholarly references