Final answer:
Promissory notes are legal promises to repay borrowed money, while mortgages are loans secured against property. Banks often sell mortgage loans on the secondary market, creating mortgage-backed securities. This system was a contributing factor in the 2008-2009 financial crisis when high-risk 'subprime' loans defaulted.
Step-by-step explanation:
Promissory notes and mortgages are essential tools in the real estate market that allow individuals to finance the purchase of property. A promissory note is a legal instrument where a borrower promises to pay back a specified sum of money to a lender at a certain time frame or on demand. Whereas a mortgage is a loan secured by the property being purchased. If the borrower fails to make payments, the lender can foreclose on the property to recover the outstanding loan balance.
The relationship between promissory notes and mortgages works such that when a person obtains a mortgage to purchase a home, they sign a promissory note as evidence of their obligation to repay the borrowed amount. In traditional banking operations, the mortgage loan would be an asset on the bank's books, but in contemporary finance, banks often sell the loan on the secondary loan market, converting the mortgage into a liquid asset. This means that the bank can offer more loans without bearing the full risk, as investors on the secondary market assume the risk and reap the benefits of the interest payments made by the borrower.
The 2008-2009 financial crisis highlighted issues with this system when banks securitized high-risk 'subprime' mortgage loans, selling them to investors as mortgage-backed securities. This practice disconnected the issuing banks from the consequences of loan default, leading to a collapse when many borrowers were unable to repay their loans. Overall, promissory notes and mortgages are interconnected instruments that facilitate home buying, but they also play a role in the broader financial system with implications that can extend to the global economy.