President

Box 2-3 — continuedmortgage defaults, the investor bears a $4,000 loss instead of a full$400,000 loss. If investors are risk-averse, this diversification makesthem better off. A security can also include portions of diverse typesof mortgages, which further spreads risk if the payment performanceon the individual mortgages is not perfectly correlated. Securitizationbenefits lenders by enabling them to sell loans to those investors whocan better handle the risks associated with mortgage borrowers. Thesale of mortgages provides lenders with cash that they can then useto supply more mortgages. Investors benefit from the availability ofadditional securities.The second economic benefit of securitization is an increase inavailable capital. More risk-diversified securities draw additional investorsinto the market, expanding the amount of capital in the market.This increased supply of credit may result in a lower cost of creditfor borrowers, which, everything else remaining equal, makes homeownership more accessible.Credit Market Disruptions in 2007There were significant disruptions in financial markets in the summer of2007. Problems became evident in June and July, when several hedge fundsreported large losses and a large mortgage lender faced mounting problems.In late July, demand for U.S. Treasury securities jumped due to a “flightto-quality”as investors shied away from mortgage-related assets, and to alesser degree, corporate bonds and other relatively riskier assets. The shiftaway from corporate bonds resulted in a wider spread between interest rateson U.S. Treasuries and those on corporate bonds, following several years ofnarrow spreads. Conditions in financial markets worsened in early August,when several hedge funds experienced large losses. One European fund evenstopped investor redemptions, saying that it was not possible to value certainsecurities. The disruptions led investors to try to maintain highly liquidpositions and to focus on assets that were perceived as less risky and moreeasily priced.Credit Market Link to MortgagesThe housing and credit markets are linked through the securitizationof mortgages. The resulting mortgage-backed securities are often furtherpackaged into other, more complicated, financial securities. Originationsof mortgages that could not be purchased and securitized by Fannie MaeChapter 2 | 61