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One of the many causes of the 2008-2011 great recession was the speculative transfer of mortgage backed securities. Unless you live in a bunker in the rainforests of Vietnam, you have probably heard this several times. But what is a mortgage backed security and how did it play a role in the recession? More importantly, what has the government done to avoid it from happening again?
Mortgage Backed Securities
Put simply, mortgage backed securities, or MBSs, are packages of home loans—from several to hundreds—sold to investors. These packages could be further divided and sold to other investors as shares in the security: a product called trenches, which could be divided again into smaller shares called collateralized debt obligations. This created a complex network of interdependent securities spread across financial institutions.
What is wrong with this system, you may ask? The answer is another buzz-word you have probably heard many times: moral hazard. Moral hazard is a tendency in economic theory where investors take undue risks because they don’t have enough skin in the game, or in other words, don’t feel the financial pain of their mistakes.
Historically, bank investors would be very careful about the mortgage applications they approved. They would check credit histories carefully and ensure everybody had the financial wherewithal to make their mortgage payments. After all, if the client defaulted on payments, it was the bank or lender that had to foot the bill. However, once mortgage backed securities became popular and banks could quickly sell on their mortgages to other investors, they became more careless about who they loaned money to and started to offer mortgages to sub-prime borrowers. After all, if the client couldn’t make the payments, some other investor, or collection of investors would have to worry about it, not them. Enter moral hazard.
In order to avoid this from happening again, the government has created new rules to regulate mortgage transfers. Previously, your mortgage could be sold, re-sold and sold again without your knowledge. In fact, you could easily own shares in your own mortgage without even realizing it. With the new rules set by the Federal Reserve, you will know who owns your loan.
This has an added benefit to home owners. If you don’t know who owns your mortgage and you want a loan modification, a loan refinance or have payment disputes, it can be difficult to know who you need to deal with. With the new rules you will know at all times who owns your mortgage and who you must deal with about payment disputes or mortgage renegotiations.
The new rules require companies that acquire your loan to send you a notice of the mortgage transfer within 30 days of the purchase. This notice must provide the new owner’s name, address and telephone number, as well as the date of the transfer and the agent authorized to act on behalf of the new owner.
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