1. Mortgage-Backed Securities, Home Values, and the Economic Crisis: Clarifying how securitizing mortgages works and how the decrease in housing prices affects the value of the securities Stephanie Rupinski Honors Senior Project Supplemental Powerpoint

2. 1. Potential home-buyer looks at purchasing a house

3. 2. Potential home-buyer goes to the bank and is approved for a mortgage loan

4. 3. All approved mortgages are pooled together Mortgage 1 Mortgage 2 Mortgage 3 Mortgage 4 Mortgage 5 Mortgage 6 Mortgage 7 Mortgage 8 MORTGAGE POOL

5. 4. Mortgage pool divided into mortgage backed securities (MBS) *Different ratings given to each MBS based on the perceived risk MBS 1 (AAA rating) MBS 2 (AA rating) MBS 3 (A rating) MBS 4 (BBB rating) MBS 5 (BB & below rating) Goldberg, S. & Giedeman, D. Healing the global financial crisis. The Journal of Corporate Accounting & Finance, September/October 2009, 14. Mortgage Pool

6. 5. Highly rated MBS divided up further; Lower rated MBS also divided up Senior ‘AAA’ rating Junior ‘AAA’ rating ‘AA’ rating ‘A’ rating ‘BBB’ rating Lowest rating Each is considered an ‘asset-backed security’- collateralized debt obligation (CDO). They could be further broken down and sold as well. Senior ‘AAA’ rating Junior ‘AAA’ rating ‘AA’ rating ‘A’ rating ‘BBB’ rating Lowest rating High Grade CDO * CDOs made from low rated MBS typically have higher interest rates due to higher risk Goldberg, S. & Giedeman, D. Healing the global financial crisis. The Journal of Corporate Accounting & Finance, September/October2009, 14.

7. 6. Investment banks invest in these securities When the assets backing these securities (houses) are growing in value, the securitized investments also grow in value. The investment banks were making a great deal of money with these instruments. Many had very little cash in their reserves- they were investing everything they had. MBS Riskier portions of CDOs (lower ratings)= higher returns

8. 7. Housing prices start to go down. Home- owners have houses where they owe more than what they’re worth- start walking away & defaulting on mortgages DEFAULT ON MORTGAGE

9. 8. Mortgages are the collateral for the MBS & CDOs- they too lose value Defaulted mortgages Quickly lose value as the assets backing them are losing value.

10. 9. Investment banks left with securities divided up so many times they cannot figure out original asset and their current value

11. 10. Commercial banks left with defaulted mortgages & investment banks left with securities decreasing in value Investment banks went from making money off these securities when housing prices going up. They did not except housing prices to go down, but when they did, all their securities and investments plummeted in value leaving them with little to no capital. Assets- decrease in value/default Any security being backed by that asset- decrease in value