To make the loans easier to sell, the banks go toFannie Mae or Freddie Macand get
(or prime mortgages*). Assurance means one of the agencies certifies that theloans are creditworthy; they also insure part of the loan in case the homeowner defaults.
Before their recentnationalization, Fannie and Freddie were
(GSEs). While anyone could buyshares in the two companies, they were also subject to federal regulation and congressional oversight
. Thisfederal role was seen as an
: While there was no explicit guarantee, all parties believed loans backed by Fannie and Freddie were absolutely safe because the government would not let the two agencies fail. Thisallowed them to borrow huge sums of money at extremely low rates.
*Prime refers to the credit score of the borrower.
Banks then sold their newly acquired
prime mortgage loans to
bundlers, ranging from Fannie and Freddie to
, such as investment banks, hedge funds and
(ones that hold deposits like savings and checking accounts.
Bundlers pooled many mortgages
with theintention of
selling the payment rights
to others, that is, someone else pays to receive your monthly mortgage payments.The next step was to
the bundle (
a security is a tradable asset
. Much of the financial wizardry of WallStreet involves turning debts into assets. Say you're Bank of America and you sell 200 mortgages in a day. LehmanBrothers buys the loans after they are assured and bundles
them by depositing the mortgages in a bank account --that's where the monthly payments from the 200 homeowners go
(MBS)iscreated from this bundle
. An MBS is a financial product that pays a yield to the purchaser, such as a hedge fund, pension fund, investment bank, money bank, central bank and especially Fannie and Freddie. The yield, essentiallyan interest payment, comes from the mortgage payments.
How does it work? The homeowner keeps making monthly mortgage paymentsto Bank of America, which makes money from the fees from the original mortgage and gets a cut for servicing themortgage payments, passing them on to Lehman Brothers. Lehman makes money as a bundler of the mortgages and
of the mortgage-backed security. The purchaser of the mortgage-backed security, say, Fannie Mae,then gets paid from the bank account holding the mortgage payments.
At first, this process covered only prime mortgages
because Fannie and Freddie could not assure subprime loans.To address low rates of home ownership among low-income populations and communities of color,