Final answer:
National economic conditions can influence mortgage defaults; banks may reduce risks by utilizing strategies like selling loans, but prolonged recessions can still lead to an increased amount of defaults and a decline in bank net worth.
Step-by-step explanation:
National economic conditions, such as a recession, will often impact the likelihood of mortgage defaults. During a recession, many individuals may struggle financially, leading to an increase in the number of loan defaults. Banks, in anticipation of these economic shifts, may employ strategies like selling loans in the secondary loan market, holding government bonds, or increasing reserves to mitigate risks. Unfortunately, a prolonged recession means that these precautions may not be enough to prevent the decline in net worth for most banks, as a higher share of loans may go unpaid during tough economic times.
The 2008 recession serves as an example where aggressive lending and other factors contributed to a rise in mortgage defaults once borrowers could no longer afford their payments. This trend was exacerbated when the adjustable-rate mortgages (ARM) reset to higher interest rates, resulting in an even larger number of defaults.