So what does the institution do?
It goes ahead and ‘securitises' these loans. Securitisation means converting these home loans into financial securities, which promise to pay a certain rate of interest. These financial securities are then sold to big institutional investors.
Many investment banks (or institutions like the ‘second American' in our story) sold complicated securities that were backed by debt which was very risky.
And how are these investors repaid? The interest and the principal that is repaid by the sub-prime borrowers through equated monthly installments (EMIs) is passed onto these institutional investors.
Image: A sign is posted in front of a bank owned home that is for sale in Richmond, California. | Photograph: Justin Sullivan/Getty Images
Also read: Ratan Tata's words of inspiration
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