Question by hetbh123: securitization and subprime investment?
I don’t really understand this concept and how these two are related are are causing the financial crisis it is today. the ethical issue that is imposing on companies such as AIG….Can someone explain to me? thank you very much.
Answer by Ed Atun
In 2003 bank accounts were paying 1% interest. Many people had their life savings in the bank. Merrill Lynch was investing money in mortgages that paid 6%. Merrill said they would pay people 5% which was great compared to 1% at the bank. Merrill made 1% profit and people got 5% on their life savings. Everyone was happy. So Merrill started loaning to people with bad credit (subprime) at 8%. The people could now get 7% on their money. Much better than 1%. Merrill still made its 1% profit on every mortgage. This worked great. Merrill was not selling mortgages to the citizens of the USA. They were selling investments in a giant pool of mortgages. When a citizen received their 7% interest, they did not own a mortgage. They owned a “security” that was invested in mortgages.
But the people with bad credit did not pay their mortgages. People quickly realized that they might not get their 7% interest. They might not get anything at all. All of a sudden, the old 1% in the bank looked very safe. So everyone pulled out at once. The money disappeared. Merrill Lynch had no money to pay employees; no money to buy new mortgages; no money to do anything. So it all folded…
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