Mortgage backed securities have been a form of financial instrument that has earned huge profits for many investment banks in the US. But unfortunately, it may also have helped brought about the current economic recession in the country. In order to fully understand how this came to be, people would need to know what mortgage backed securities actually are.

Shares For Mortgage Payments

The mortgage backed securities came by way of trying to pool together a collection of different mortgage loans and consolidate them together and convert them into something that can be traded as shares.

They become quite attractive as investments since they provide a regular stream of revenue in terms of the mortgage payments made by the borrowers who are also homeowners.

In time, larger investment banks were buying sets of mortgages from smaller banks, consolidating them and then converting them into mortgage backed securities to be sold as shares for interested investors.

Housing Mortgage And MBS

Mortgage backed securities became attractive investments just about the time when the housing boom has taken in almost all of the qualified borrowers. Prior to its popularity, banks usually handled credit the old fashioned way- with due diligence.

In order for a new home owner to qualify for a mortgage, financial stability needed to be established. Banks needed to look into a borrower’s income, debt as well as credit rating and be verified before any loans can be approved.

Effect on Mortgage Handling

By the time mortgage backed securities were becoming popular, the market for qualified borrowers also began to shrink. More of them already owned homes. This led to more banks looking for another segment to provide mortgage loans to. And this is when banks began to look at subprime lenders.

Hand In Recession

What gave mortgage backed securities the hand into the current recession ever happening was the less stringent measures they brought along with them when it comes to housing loan approvals. This is due to the fact that banks have the option to sell their set of mortgage loans to interested investment banks who can convert them into mortgage backed securities.

Because of the introduction of MBS’s, bank lenders can assume a lesser level of risk when it comes to mortgage approvals. Lenders now have the means to approve mortgages even without looking into or verifying a borrower’s credit standing to see if they have the means to repay what they borrow.

Instead, lenders started approving loans to subprime borrowers and to people with poor credit ratings just for the sake of getting more mortgage loans that they can eventually sell to larger banks who convert them into MBS’s.

The investments on MBS’s and the subsequent practice of subprime lending went well for a while until the financial sector began experiencing more and more foreclosures, thanks to lending money to borrowers who did not have the means to repay them. This further resulted in homes becoming less of a value than what their owners are paying for them. This realization even led to more homeowners opting for foreclosure.

The resulting foreclosure began to affect investments in MBS’s. The big investment banks began to see their securities rapidly dwindling in value. It came to a point where some investment banks that heavily invested in MBS’s defaulted because of the huge losses they suffered. This led to a domino effect that has resulted in the current recession plaguing not only the US but also the whole world.