What Is Mortgage-Backed Security (MBS)?

A mortgage-backed security (MBS) is an investment similar to a bond that

is made up of a bundle of home loans bought from the banks that issued
them. Investors in MBS receive periodic payments similar to bond coupon
payments.

KEY TAKEAWAYS

 Mortgage backed securities (MBS) turn a bank into an intermediary

between the homebuyer and the investment industry.
 The bank handles the loans and then sells them at a discount to be
packaged as MBSs to investors as a type of collateralized bond.
 For the investor, an MBS is as safe as the mortgage loans that back it
up.
Volume 75%
 
1:54

Understanding Mortgage-Backed Securities

Understanding Mortgage-Backed Security (MBS)

Mortgage-backed security (MBS) is a variation of an asset-backed
security but one that is formed by pooling together mortgages exclusively.
The investor who buys a mortgage-backed security is essentially lending
money to home buyers. An MBS can be bought and sold through a broker.
The minimum investment varies between issuers.

As became glaringly obvious in the subprime mortgage meltdown of 2007-

2008, a mortgage-backed security is only as sound as the mortgages that
back it up. An MBS may also be called a mortgage-related security or a
mortgage pass-through.

Essentially, the mortgage-backed security turns the bank into an

intermediary between the homebuyer and the investment industry. A bank
can grant mortgages to its customers and then sell them at a discount for
inclusion in an MBS. The bank records the sale as a plus on its balance
sheet and loses nothing if the homebuyer defaults sometime down the
road.
This process works for all concerned as everyone does what they're
supposed to do. That is, the bank keeps to reasonable standards for
granting mortgages; the homeowner keeps paying on time, and the credit
rating agencies that review MBS perform due diligence.

In order to be sold on the markets today, an MBS must be issued by

a government-sponsored enterprise (GSE) or a private financial
company. The mortgages must have originated from a regulated and
authorized financial institution. And the MBS must have received one of the
top two ratings issued by an accredited credit rating agency.

 
Mortgage-backed securities loaded up with subprime loans played a central
role in the financial crisis that began in 2007 and wiped out trillions of
dollars in wealth.

There are two common types of MBSs: pass-throughs and collateralized

mortgage obligations (CMO).

1. Pass-Throughs: Pass-throughs are structured as trusts in which

mortgage payments are collected and passed through to investors.
They typically have stated maturities of five, 15, or 30 years. The life
of a pass-through may be less than the stated maturity depending on
the principal payments on the mortgages that make up the pass-
through.
2. Collateralized Mortgage Obligations (CMO): CMOs consist of multiple
pools of securities which are known as slices, or tranches. The
tranches are given credit ratings which determine the rates that are
returned to investors.

MBS and the Financial Crisis

Mortgage-backed securities played a central role in the financial crisis that
began in 2007 and went on to wipe out trillions of dollars in wealth, bring
down Lehman Brothers, and roil the world financial markets.

In retrospect, it seems inevitable that the rapid increase in home prices and
the growing demand for MBS would encourage banks to lower their lending
standards and drive consumers to jump into the market at any cost.

That was the beginning of the subprime MBS. With Freddie Mac and

Fannie Mae aggressively supporting the mortgage market, the quality of all
mortgage-backed securities declined and their ratings became
meaningless. Then, in 2006, housing prices peaked.

Subprime borrowers started to default and the housing market began its
long collapse. More people began walking away from their mortgages
because their homes were worth less than their debts. Even the
conventional mortgages underpinning the MBS market saw steep declines
in value. The avalanche of non-payments meant that many MBSs and
collateralized debt obligations (CDO) based off of pools of mortgages were
vastly overvalued.

The losses piled up as institutional investors and banks tried and failed to
unload bad MBS investments. Credit tightened, causing many banks and
financial institutions to teeter on the brink of insolvency. Lending was
disrupted to the point that the entire economy was at risk of collapse.

In the end, the U.S. Treasury stepped in with a $700 billion financial system
bailout intended to ease the credit crunch. The Federal Reserve bought
$4.5 trillion in MBS over a period of years while the Troubled Asset Relief
Program (TARP) injected capital directly into banks.

The financial crisis eventually passed, but the total government

commitment was much larger than the $700 billion figure often cited.

MBSs are still bought and sold today. There is a market for them again
simply because people generally pay their mortgages if they can. The Fed
still owns a huge chunk of the market for MBSs, but it is gradually selling off
its holdings. Even CDOs have returned after falling out of favor for a few
years post-crisis. The assumption is that Wall Street has learned its lesson
and will question the value of MBSs rather than heedlessly buying them.
Time will tell.

What Is Mortgage-Backed Security (MBS)?

A mortgage-backed security (MBS) is an investment similar to a bond that
is made up of a bundle of home loans bought from the banks that issued
them. Investors in MBS receive periodic payments similar to bond coupon
payments.
KEY TAKEAWAYS

 Mortgage backed securities (MBS) turn a bank into an intermediary

between the homebuyer and the investment industry.
 The bank handles the loans and then sells them at a discount to be
packaged as MBSs to investors as a type of collateralized bond.
 For the investor, an MBS is as safe as the mortgage loans that back it
up.
Volume 75%
 
1:54

Understanding Mortgage-Backed Securities

Understanding Mortgage-Backed Security (MBS)

Mortgage-backed security (MBS) is a variation of an asset-backed
security but one that is formed by pooling together mortgages exclusively.
The investor who buys a mortgage-backed security is essentially lending
money to home buyers. An MBS can be bought and sold through a broker.
The minimum investment varies between issuers.

As became glaringly obvious in the subprime mortgage meltdown of 2007-

2008, a mortgage-backed security is only as sound as the mortgages that
back it up. An MBS may also be called a mortgage-related security or a
mortgage pass-through.

Essentially, the mortgage-backed security turns the bank into an

intermediary between the homebuyer and the investment industry. A bank
can grant mortgages to its customers and then sell them at a discount for
inclusion in an MBS. The bank records the sale as a plus on its balance
sheet and loses nothing if the homebuyer defaults sometime down the
road.

This process works for all concerned as everyone does what they're
supposed to do. That is, the bank keeps to reasonable standards for
granting mortgages; the homeowner keeps paying on time, and the credit
rating agencies that review MBS perform due diligence.

In order to be sold on the markets today, an MBS must be issued by

a government-sponsored enterprise (GSE) or a private financial
company. The mortgages must have originated from a regulated and
authorized financial institution. And the MBS must have received one of the
top two ratings issued by an accredited credit rating agency.

 
Mortgage-backed securities loaded up with subprime loans played a central
role in the financial crisis that began in 2007 and wiped out trillions of
dollars in wealth.

There are two common types of MBSs: pass-throughs and collateralized

mortgage obligations (CMO).

1. Pass-Throughs: Pass-throughs are structured as trusts in which

mortgage payments are collected and passed through to investors.
They typically have stated maturities of five, 15, or 30 years. The life
of a pass-through may be less than the stated maturity depending on
the principal payments on the mortgages that make up the pass-
through.
2. Collateralized Mortgage Obligations (CMO): CMOs consist of multiple
pools of securities which are known as slices, or tranches. The
tranches are given credit ratings which determine the rates that are
returned to investors.

MBS and the Financial Crisis

Mortgage-backed securities played a central role in the financial crisis that
began in 2007 and went on to wipe out trillions of dollars in wealth, bring
down Lehman Brothers, and roil the world financial markets.

In retrospect, it seems inevitable that the rapid increase in home prices and
the growing demand for MBS would encourage banks to lower their lending
standards and drive consumers to jump into the market at any cost.

That was the beginning of the subprime MBS. With Freddie Mac and

Fannie Mae aggressively supporting the mortgage market, the quality of all
mortgage-backed securities declined and their ratings became
meaningless. Then, in 2006, housing prices peaked.

Subprime borrowers started to default and the housing market began its
long collapse. More people began walking away from their mortgages
because their homes were worth less than their debts. Even the
conventional mortgages underpinning the MBS market saw steep declines
in value. The avalanche of non-payments meant that many MBSs and
collateralized debt obligations (CDO) based off of pools of mortgages were
vastly overvalued.

The losses piled up as institutional investors and banks tried and failed to
unload bad MBS investments. Credit tightened, causing many banks and
financial institutions to teeter on the brink of insolvency. Lending was
disrupted to the point that the entire economy was at risk of collapse.

In the end, the U.S. Treasury stepped in with a $700 billion financial system
bailout intended to ease the credit crunch. The Federal Reserve bought
$4.5 trillion in MBS over a period of years while the Troubled Asset Relief
Program (TARP) injected capital directly into banks.

The financial crisis eventually passed, but the total government

commitment was much larger than the $700 billion figure often cited.

MBSs are still bought and sold today. There is a market for them again
simply because people generally pay their mortgages if they can. The Fed
still owns a huge chunk of the market for MBSs, but it is gradually selling off
its holdings. Even CDOs have returned after falling out of favor for a few
years post-crisis. The assumption is that Wall Street has learned its lesson
and will question the value of MBSs rather than heedlessly buying them.
Time will tell.