Final answer:
Mortgage practices transitioned from lenders taking physical possession of properties to borrowers pledging homes as security with retention of possession. The rise of the secondary loan market allowed banks to sell mortgages, transferring risk and allowing valuation of long-term loans. This evolution played a role in the 2008-2009 Great Recession when the value of mortgage-backed securities was overestimated, exposing banks and households to financial risks.
Step-by-step explanation:
The historical shift in mortgage practices has been significant. In traditional mortgage models, lenders sometimes took physical possession of the property until the loan was paid off. Over time, however, the modern practice evolved where borrowers retain possession of their home but pledge the property as security, providing lenders with a lien against the property in case of default.
Initially, mortgages were often handled by local banks that bore the full risk of default. With the rise of diverse financial institutions engaging in mortgage lending, risk began to be distributed differently. These institutions did not only issue home loans but also sold them in the secondary loan market, allowing them to recoup some value immediately and transfer risk to other entities. This market facilitates the buying and selling of loans, and it became a crucial element in measuring the present value of long-term loans like mortgages.
The shift to this modern approach was significant, but it was not without risks, as revealed during the housing market downturn that preceded the 2008-2009 Great Recession. The fall in housing prices led to situations where the owed amounts surpassed home values, which, combined with the riskier-than-expected mortgage-backed securities, weakened both bank and household finances and significantly contributed to the financial crisis.