The Crisis: Basic Mechanisms And Appropriate Policies

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Executive Summary

Conditional on no housing price decline, most subprime mortgages appeared relatively riskless: The value of the mortgage might be high relative to the price of the house, but it would slowly decline over time as prices increased. In retrospect, the fallacy of the proposition was in its premise: If and when housing prices actually declined, many mortgages would exceed the value of the house, leading to defaults and foreclosures. Securitization had started much earlier, but changed scale in the last decade. In mid-2008, more than 60 percent of all U.S. mortgages were securitized. In the mortgage market, mortgages were pooled to form mortgage-based securities (MBS), and the income streams from these securities were separated ("Tranched'') further to offer more or less risky flows to investors.

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