Greed and Fear Direct the Market: A Case of Mortgage-Backed Securities

Abstract One of the utmost inventions in the US financial markets may be the creation of Mortgage-Backed Securities or MBS. MBS market is estimated recently to be approximately 6 times the market capitalization of Bombay Stock Exchange. MBS are securities issued by banks or housing finance institutions based on certain pool of mortgages (housing loans). The process of creating and issuing securities based on a pool of certain assets is called Securitization. A sub-prime loan is linked with weak type of credit. In US, a sophisticated system has developed for rating individual's credit worthiness in form of credit scores, based on their level of income, fixed expenses, debts, and their payment history. MBS is based on a pool of loans, which may include sub-prime loans. Financial institutions created and made significant investments in mortgage-backed securities backed by high-risk subprime mortgages out of greed, but when defaults increased, anxiety grew and the MBS market and housing bubble collapsed, igniting the global financial crisis of 2008.The housing bubble was fueled by risky loans and intricate derivatives from lenders looking to make money and investors enticed by large returns. The value of MBS crashed as home prices dropped and subprime borrowers defaulted, causing widespread fear and a credit crunch that endangered financial institutions and the world economy.