Word: defaults
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...right. But with the economy in uncharted territory, we'll come to recognize that party-line adherence to old political convictions won't provide any easy way out. Given that it was our unthinking trust in the unthinking certainty of "experts" that got us here - securitized debt? credit-default swaps? uh, sure, whatever - Americans can now revert to their ruthlessly pragmatic, commonsensical selves. Admitting that we aren't certain exactly how to proceed is liberating, and key. Hyperbolic rants and rigid talking points, in either Limbaughian or Olbermannian flavors, now seem worse than useless, artifacts of a bumptious barroom...
...bundle loans into a pool that could then be sold to other banks. The bank purchasing the loans would then hold them as an investment or resell them in the secondary market. This market improved the ability of banks to lend by transferring the risk of the loan default to a third party while providing financing to the bank to make new loans. In time, the public grew accustomed to the increased availability of credit. (See pictures of the printing of money...
...result of declining home prices, if a borrower defaults on their mortgage, market prices for the home would be less than the balance on the mortgage. However, since MBS derive their value from a pool of loans - typically thousands of individual mortgages - the default of some portion of the mortgages would not mean the security had no value, only a reduced value. Unfortunately, banks, in an effort to increase their investment returns, exacerbated the problem by using enormous leverage to purchase and securitize mortgage loans. Thus, even if MBS's value declined because of defaults, because...
...Finally, the seemingly unprecedented drop in prices together with increased default rates made it nearly impossible to assign value to MBS. As a consequence, MBS that had some intrinsic value were illiquid, and banks were forced to keep the toxic assets on their balance sheets...
...principal payments on the underlying loans first going to the senior most tranche and the last payments going to the most junior. Effectively, the tranches are, at least in part, rated differently based upon the order in which they receive payment from the underlying loans. In the event of default, the junior most tranche may receive less than their regular return because they are the last tranche to be paid. In order to compensate for the increased risk, the more junior the tranche is, the higher the yield on the investment. Employing this system, loans that individually had varying credit...