Developments in the Mortgage Market

Traditionally, mortgage lenders, such as banks that issued home loans, kept them on their books and bore the risk if borrowers defaulted.

Securitization reshaped the mortgage market. Under this process, an original mortgage lender, such as a bank, made loans and then sold them to other institutions.

These institutions could be government-sponsored enterprises and private financial institutions.

These institutions bundled mortgages into financial products called mortgage-backed securities (MBS) and sold them to investors.

At first, this looked like a clever way to spread risk.

Imagine a large pool of thousands of mortgages. Even if a few homeowners defaulted, investors assumed the rest would keep paying, making the security appear safe.

MBS often carried high credit ratings, making them attractive to investors.

The system changed lender behavior. As many lenders could quickly resell loans, they had less incentive to scrutinize borrowers, which contributed to rising housing demand and higher prices.

Investment banks went further, repackaging MBS into complex instruments such as collateralized debt obligations (CDOs).

Ultimately, securitization helped fuel the housing bubble.