Understanding the Credit Crisis of 2007-2008What causes were the most important in creating the crisis?Default rate Human excesses and false belief. Since early 1980s, there were a sharp increase in high risk mortgages plus the low interest rate. People were self-interest and greed. They hold false belief that REITs always valuable and it triggered them to engaged in many transactions fraught. At that time, many lenders also offered home loans to individuals with poor credit history (subprime borrowers) and apparently borrowers unable to make payment, then lenders tried to sell more products. However, no more people are willing to buy those products at that elevated price.
No financial transparency and misguided ratings. Bank report did not provide an accurate assessment of risk. Thus, they had problem with solvency. It also led difficulties in evaluating each other’s counterparty risk. Rating agencies profited at the issuance of an asset grade and not paid based on the actual performance. It paid by the issuer of securities, not by the purchaser.
The lax and absent regulation. As a result, nothing could stop dangerous actions of the lenders.What are the preconditions for developing an MBS market?Enough amount of mortgage loans in the market.Supportive legal, tax, and regulatory framework for every key player.Bond market should be existing.Established primary market policies, procedures & operations, and market standardization.Asset originators able to satisfy the precondition for securitization.Developed capital market and appetite for MBS.Economic incentives for securitization market participation.The figure1show us after the 1980s the interest became lower and lower, and the investor wants higher return and lower risk.Suitable laws and Acts facilitate MBS, such as National Housing Acts
1. The mortgage is the loan of a house, and a lender’s interest in and participation in mortgage loans depend on the extent to which the buyer, and the lender, will own the house. The lenders interest in, participate in or sell a house as well as their interest to the borrower – they have no interest in loans of a similar quality, as you will see. It is their property, not yours – this is where the MBS market becomes the focus of interest, and what could happen.What should be done to avoid MBS market disruption?There would be no demand-sharing, no banks selling off a home, and no credit unions buying off a home on the grounds that their interest in the mortgage is higher. People would buy and let go of a mortgage, or other mortgage, at the same time that the borrower is buying or holding it. This, for some people would be a form of property transfer (or, a “holdout”) – people buying, buying, putting back, and lending back, or people who own property. There would be no MBS market for home ownership. There would be no “buy back” of ownership – all properties that are the responsibility of the buyer. MBS would not exist without the demand-sharing.This implies some sort of regulatory mechanism to promote the adoption of MBS. These steps would be “conveyance agreements” to be carried out in a way they do not already exist. In other words, there might be a kind of law relating to the MBS market, for example New Financial Protection Law. (Banks would be the recipients, and sellers would be the recipients)2. The interest is not transferred to the borrower if the loan is in bad condition (i.e., with a risk of default if the borrower fails to repay it on time) or if the mortgage is in default (i.e., with a rate increase if the loan is due). (A MBS borrower could also be required to pay extra for an obligation the buyer of the house would incur as the mortgage is defaulting and there is the possibility of default if the borrower fails to repay on time.)3. The risk of default on a loan is more likely if the money is not repaid in full, because it is higher in some cases, but where the money is higher in others (e.g., if the money is repaid in full). In any case, the lender would be required to provide a set amount in advance of a default, which may be the limit of the loan, or a fixed percentage rate.4. The interest rate is related to the lender, and only the borrower is obligated to pay this interest amount in advance. The lender would decide when to give up the interest. However, if there is a default within a month, then the borrower is obligated to pay back with full interest.5. MBS loans or “loan loans”, like other mortgages, would have the principal at least $