Appendix D
The Collapse of the Asset Securitization Market
The collapse of the asset securitization market was triggered in early 2007 by the significant increases in delinquencies and defaults of subprime mortgages. The poor credit performance resulted in losses for investors and scared them away from the market. As investors fled, the prices of subprime mortgage-backed securities declined (yield spreads widened). The wider yield spreads made the funding of new mortgages more difficult and costly. It put originators in financial stress. Widening yield spreads also created losses for investment bankers, who underwrote subprime mortgage-backed securities. Meanwhile, rising defaults forced originators to foreclose, which depressed housing prices (already hard pressed by the escalation of interest rates) and further lowered the prices of mortgage securities. This vicious cycle generated still more losses for investors, originators, and investment bankers alike. As investment bankers withdrew from making markets for subprime mortgages, liquidity started to dry up, causing further widening in mortgage yield spreads.
Increasingly wider mortgage yield spreads led to huge losses for portfolio investors (banks, insurance companies, GSEs, etc.) The credit crisis now became a liquidity crisis and banks basically stopped lending. The liquidity crisis worsened to become a financial crisis, as financing became scarcely available for businesses and consumers. With little financing, economic ...
