Final answer:
Securitization of mortgage loans in the mid-1980s was a process where mortgage lenders sold mortgages to companies that pooled them into mortgage-backed securities for investors.
This transferred the risk of default from the lenders to the investors and led to an increase in subprime lending, contributing to the financial crisis of 2008-2009.
Step-by-step explanation:
The securitization of mortgage loans in the mid-1980s refers to a financial process where lenders sell their mortgages to financial companies.
These companies pool the mortgages to create large financial securities, known as mortgage-backed securities (MBS), which they then sell to investors.
This process of securitization shifted the risk from lenders to investors, as investors would then receive income based on the repayment of these pooled mortgages.
Investors found mortgage-backed securities attractive as they seemed to provide a steady stream of income, contingent on the borrowers' ability to repay their mortgages.
Credit rating agencies were responsible for assessing the risk of these MBS, but in hindsight, they are often criticized for being too lenient with their ratings. Regulatory bodies observed the burgeoning market for mortgage-backed securities but did not intervene, believing there was no need at the time.
However, this separation of financial interest between the lender and the ability of the borrower to repay led to an increase in risky lending practices.
Banks began to make subprime loans, with potentially low scrutiny of the borrower's financial stability because they no longer had to bear the consequences if the borrower defaulted. These practices contributed to the financial crisis of 2008-2009.