Pathology of the US Mortgage Crisis

by Mayiz Habbal, PhD, March 31, 2008


New York, NY, USA March 31, 2008

In the past nine months the global credit market saw a "flight from uncertainty" that dislocated market liquidity, caused enormous writedowns across asset classes and geographies, panic interest rate cuts in the US, and the fall of Bear Stearns, the once fifth-largest US investment bank.

The speed, severity, and magnitude of the turmoil that has swept through the financial markets in the past nine months has taken many market participants by surprise. What started as a US subprime mortgage crisis has turned into a global credit crunch. The turn of events was breathtaking. In a new report, , Celent attempts to explain how the US subprime crisis precipitated a major global economic downturn by providing answers to the following questions:

  • What actually happened?
  • Why did it happen?
  • How will the US mortgage industry change?

At the core of the recent turmoil is an altered mortgage business model. With the remarkable growth in securitization, the simple "originate and hold" model has evolved to incorporate an alternative and more complex "originate to distribute" model. The incentives in this model have encouraged large-scale production of low quality mortgages. Diffuse distribution of risk followed in this context, as credit risk was removed from the originating institutions and dispersed via the capital markets in the form of risk-bearing securities. The fragility of this system became evident as the drop in US house prices precipitated high default levels among over-leveraged borrowers, Exposure to the these losses was transmitted partly via the securitization market to financial institutions around the world.

Source: Oliver Wyman

"Despite its evolution, the 'originate to distribute' model has not become obsolete," says Mayiz Habbal, SVP of Celent's Securities & Investments group and co-author of the report. "There will still be a need for securitization and investors willing to hold the resulting bonds. As such, this model is here to stay. However, it will undoubtedly change and be derisked."

The 27-page report contains 22 figures and one table. A table of contents is available online.

Members of Celent's research services can download the report electronically by clicking on the icon to the left.  Non-members should contact for more information.  

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned operating unit of Marsh & McLennan Companies [NYSE: MMC].

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Table of Contents

New York, NY, USA March 31, 2008

Executive Summary 04
Introduction 05
The Mortgage Business Model in 1987 06
Originate to Distribute Business Model 09
The Mortgage Industry Beyond 2005 13
The US Subprime Crisis 18
From a US Subprime Crisis to a Global Liquidity Crisis 21
Conclusions and Predictions 27


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