Saundra McDavid

How did a $250k mortgage result in a financial crisis?

A family without sufficient income purchases home from a local bank or mortgage broker
The mortgage is sold to an investor during a process called securitization. These investors purchase the loans and package them up into a product called a mortgage backed security (MBS). The MBS is sold to investment banks, which then package multiple MBS’s into Collateralized Mortgage Obligations (CMO’s) The CMO is sold to institutional investors, investment banks, pension funds and insurance companies who re-package them into different risk categories. The result is that the balance sheets of these large firms depend on the payback of these sub-prime mortgages. Add into the mix dropping home values and a larger than expected default rate on those sub-prime loans, and those companies that insured the mortgages against default could no longer pay the insurance premiums to the holders of the CMO’s. So now no one knows how much the assets are really worth, since the insurance companies may or may not pay if the mortgage holder defaults. And this resulted in banks ceasing lending to other banks because they don’t know the value of the assets of those other banks.

But how does this all result in another depression?

I still eagerly await someone to clearly articulate the doomsday that was touted as a foregone conclusion without “The Bailout.” An economist pontificating on television the cause of the Great Depression blamed bigger government and more regulation as the cause – something we just spent $700 billion implementing. Back then FDR raised taxes on businesses which caused businesses to shut down. This may have been a major factor prolonging the Great Depression. The answer is not bigger government – any Republican should know this. You can’t legislate yourself out of a depression. Obama has listed many admirable but expensive goals which result in bigger government and more spending. McCain has vowed to put a virtual spending freeze on the federal government. However both voted for the bailout. Both will be equally to blame for its ineffectiveness.

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