The Subprime Mortgage Crisis — How MBS and CDOs Shook the World
Why did a fall in U.S. home prices shake even banks in Korea and Europe? The answer lies in the financial link called "securitization."
What Is Subprime
Subprime refers to borrowers with low credit. In the 2000s U.S., under the belief that home prices would keep rising, loans with loose verification of income, employment, and assets surged.
In particular, there were many adjustable-rate products that applied low rates at first and then sharply higher rates later. As long as home prices were rising, borrowers could hold on by refinancing, but the structure was one in which delinquencies exploded the moment home prices turned down.
MBS and CDOs — the Repackaging of Risk
Banks bundled thousands of individual loans together and sold them to investment banks, which issued mortgage-backed securities (MBS) on that basis. MBS holders receive a portion of the money borrowers repay each month.
Going one step further, bundling multiple MBS again produced collateralized debt obligations (CDOs). "If an MBS is a basket of loans, a CDO is a basket holding baskets." As risk was repackaged in multiple layers, it became hard to grasp what was actually inside.
More complex does not mean safer; the more complex, the harder it is to see the risk. This is why the principle "do not invest in products you don't understand" is important.
Rating Agencies and Worldwide Spread
Rating agencies like Moody's, S&P, and Fitch assigned the top rating of AAA en masse to these complex securities. Trusting these ratings, banks, pension funds, and insurers around the world bought MBS and CDOs.
So when U.S. home prices fell, the losses did not stay in the U.S. but spread simultaneously to financial institutions worldwide. "Securitization" seemed to disperse risk, but in reality it had connected risk across the entire world.
よくある質問
Q. Is securitization itself bad?
Not really. Turning loans into securities and selling them is a normal financial technique that keeps money circulating. The problem lay in mixing in bad loans, hiding the risk in multiple layers, and then selling it with a wrong top rating. It was a failure of verification and transparency rather than of the tool itself.
Q. Do MBS and CDOs still exist today?
Yes, MBS remain one pillar of a huge bond market. However, since 2008 regulation has been strengthened and screening standards have become stricter. For investors, what matters is whether you can understand "where this product's risk comes from."
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