Note: This article originally appears on WealthLift.com and can be seen here.
In 2006, the underpinnings of the American financial system began to crack from a speculative bubble in the country’s housing market. Fueled by irrational exuberance in which homeowners believed their home prices would rise forever, this was made worse by Main Street and Wall Street, both of whom repackaged mortgage loans for sale to everyday investors through a process called securitization. That’s right, this was a multipronged problem, not the hell-bent desires of a few financial fat cats, as Occupy Wall Street would have you believe.
When the bubble burst and home prices began to decline, this not only hurt the original lender, but also every investor that held a piece of a mortgage-backed asset. Imagine this process like a moldy pie that no one realizes is bad. Originally, the entire pie is held by one bank. Next, pieces of this pie are sold to other banks, pension funds, hedge funds, and anyone else that has an appetite. Soon enough, however, everyone holding this pie has gotten sick. Well, this happens with all kinds of assets, including car loans, credit cards and student loans. The benefit of securitization is that it allows organizations to grant more loans to people like you and me, but the downside is that it exposes the entire economy to the financial woes of an individual market. Without securitization, what happened in the housing market would have likely stayed in the housing market.
Six years later, many people are crying that the same thing will happen to the student loan market. While disbelievers can claim that these are just ‘cynics’ whose views are skewed by the world’s ongoing economic turmoil, a basic investigation into the matter yields some worrying results.
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