Securitization Case

Securitization is a process where Wall Street buy mortgages, (sometimes even subprime mortgages), and later package them into securities to sell to investors who look for short-term profit. This whole way of gaining short-term profit all started when Chairman Alan Greenspan of the Federal Reserve agreed to keep the bank interest as low as one percent. Instead of buying treasury bills, many bankers and investors turned to securitization. At the same time, it became very easy to borrow from the bank with only one percent of interest, and thus, left with a huge leverage. This gave wall street an idea on how to connect investors with homeowners.

Every times after a family put down a down payment for a new house, their mortgage broker helps them contact a mortgage lender who will give the family a loan. It all works very nice until an investment banker tries to buy the mortgage and bundle it up with the rest of mortgages that he bought. And the investment investment banker would divide his bundle of mortgages into various levels of security: Safe, Okay and Risky or AAA, AA, A,BBB, and BB. The riskier a security is, the more profit one might get back. But on the other hand, the riskier a security is, the more chance that one might be losing all his investment. And this is called CDO or collateralized debt obligation. At first, bankers, investors and businessmen are receiving a lot of profit, way higher than what they would receive from one percent of interest rate. More and more investors want a piece of the profit, and therefore, they ask for more CDO. The banker then goes to mortgage lenders asking for more mortgages. But eventually, all the families that qualify for a loan got a house already, and this is when bankers began to buy up subprime mortgages. These people often don't have a reliable income to pay for their monthly payment. One day, a few homeowners default their mortgages and the banker needs to sell the house. But since there is more supply than demand, house values decrease tremendously. The reason why securitization affected everyone is that the banks no longer have any money, and many people's life saving are all gone. Many large corporations lost money because they invested in securities that bank can no longer afford to pay. Those corporations that can't pay for their debts go for bankruptcy, and more stockholders suffer. And everyone starts to panic and start saving instead of spending money. It is like an economic chain, whenever a link breaks down the whole chain falls apart.