Q:

How can mortgage-backed securities bring down the U.S. economy?

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Quick Answer

Mortgage-backed securities possess a unique potential for doing widespread harm due to a combination of their highly speculative nature and their ubiquitous presence throughout the financial marketplace. According to HowStuffWorks, mortgage-backed securities are the underlying commodity that backs a large number of exotic derivatives and other financial instruments that together have the potential to bring down multiple systems when the underlying commodity falters.

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Full Answer

Mortgage-backed securities were at the heart of the 2008 financial collapse that shut down some of the most venerable financial institutions on Wall Street. The problem, according to HowStuffWorks, was in the subprime mortgage market. The extensive leveraging of risky mortgages that took place in the years preceding the collapse set up a market in which a general decline in mortgage values caused not just a financial loss for the lenders, but a shortfall in financial products, investment insurance and the elaborate derivatives market built on them.

Using mortgages as the underlying commodity in a derivatives market was not in itself overly risky behavior. A 30-year mortgage is after all usually a long-term investment. Unfortunately, according to HowStuffWorks, many of the mortgages that were written during the years leading to the collapse were issued without due diligence. Without traditional safeguards against the writing of bad loans, widespread defaults and foreclosures became inevitable. When the mortgages were no longer being paid, the revenue stream to second- and higher-level derivatives dropped, causing a generalized collapse.

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