Economic Recession- Is Securitised Debt A Good Investment Or Not?
The credit crunch faced by financial institutions has called into question a disregard for all securitised debt.
In this context, we are mainly concerned about the mortgage bonds that were packed up for resale under securitised debt. Over the last few years, the mortgage default rate in United States was nearly 1.5% of the total mortgage loans provided. However, it must be noted that not all mortgage debts were defaulted likewise.
The mortgage default rate as seen in the case of Fannie Mae and Freddie Mac, were higher than that in the main financial institutions. The main reason for this lays in the loan type and the guarantee system of the mortgage. The reason behind the existence of Fannie Mae and Freddie Mac was the new deal of Roosevelt that intended to have the Federal Government support and guarantee lending, which would permit the economy of the 1930’s to spring back to normality after the ‘Great Depression’. The New Deal policy helped to support the construction industry to start up again.
However, both the establishments have now failed, because the default rates on low mortgages was just too high. What about the large and main financial institutions? How did they manage to face the situation?
When the larger mortgages went out of the remitting capability of Fannie Mae or Freddie Mac, the banks themselves had to analyze their repayment potentials and get it covered by their packaged refinance bonds.
If you carefully take a look at the overall lending and mortgage default rate, then at the time when 1.5% was the figure, and both the construction companies failed, then it becomes quite easy to determine that these had amazingly high non-payment rates, whereas another lending had quite lower default rates.
If, supposedly, the 1.5% default rate is completely applied to the loan providers and the non-Federal guaranteed mortgage, and if we consider that the risk gets covered by the interest rates, then the mortgage bonds would be a really profitable investment.
But the default rates caused the property market to drop and the houses went into negative equity and thereby the security debt became financial instruments that no one wanted to buy.