Final answer:
Securitization is a process where banks pool various types of loans into securities that are then sold to investors, mitigating risk and not requiring banks to maintain excess funds for lending. This process became notably problematic during the 2008-2009 financial crisis due to widespread loan defaults.
Step-by-step explanation:
What is Securitization of Financial Assets?
Securitization is a financial process where various types of assets, such as loans, are pooled together to create a new security. This newly formed financial instrument is then sold to investors. In the case of banks, engaging in securitization allows them to offload local loans, thus avoiding the risk tied to the local economy.
By acquiring a mortgage-backed security with home loans from different areas, the bank diversifies its risk exposure. For the homebuyers, this process ensures that local banks don't require a significant surplus of funds for loans, as they plan to sell these loans shortly after their origination.
During the 2008-2009 financial crisis, many banks adopted this method, selling mortgage loans after creation, which were then securitized. These mortgage-backed securities provided a return based on the mortgage payments received from homeowners. However, the failure of large numbers of mortgage holders to keep up with payments was a central element contributing to the financial crisis.