A Mortgage-Backed Security (MBS) is a type of asset-backed security that is secured by a collection of mortgages. These securities are created by pooling together numerous mortgages and selling them as bonds to investors. The principal and interest payments from the borrowers of the underlying mortgages are passed through to the investors of the MBS.
How Do MBS Work?
Mortgage-backed securities are created through a process called securitization. Here’s a step-by-step overview:
Securitization Process
- Origination: Mortgages are issued by banks or other lending institutions.
- Pooling: These mortgages are pooled together into a single portfolio.
- Issuance: The portfolio is then sold to a special purpose vehicle (SPV), which converts it into securities.
- Tranching: The securities are divided into different tranches, each with distinct risk and return profiles.
- Sale: These securities are sold to investors in the form of bonds, offering a return based on the underlying mortgage payments.
Types of Mortgage-Backed Securities
1. Pass-Through Securities
Pass-through securities are the simplest form of MBS. Cash flows from the underlying mortgages are collected and passed through to the securities holders proportionally.
2. Collateralized Mortgage Obligations (CMOs)
CMOs are more complex MBS that are divided into tranches. Each tranche has different characteristics in terms of maturity, risk, and interest rates.
Historical Context
MBS began gaining prominence in the 1970s when the Government National Mortgage Association (Ginnie Mae) guaranteed the first mortgage pass-through security. Their development played a significant role in the housing finance system, offering lenders more liquidity and borrowers lower mortgage rates.
Impact on Financial Markets
Mortgage-Backed Securities have a profound impact on the financial markets. They:
- Improve Liquidity: Allow lenders to reinvest their funds in new mortgages.
- Risk Redistribution: Spread the risk of mortgage default among a large pool of investors.
- Influence Interest Rates: Affect interest rate benchmarks, like the London Interbank Offered Rate (LIBOR).
Related Terms
- Asset-Backed Security (ABS): A security backed by a pool of assets other than real estate mortgages.
- Securitization: The process of pooling various types of contractual debt and selling their related cash flows to third-party investors as securities.
- Tranche: A slice or segment of a pooled collection of securities.
FAQs
What is the main difference between CMOs and pass-through securities?
Are MBS safe investments?
How did MBS contribute to the 2008 financial crisis?
Summary
Mortgage-Backed Securities (MBS) offer a way to invest indirectly in the real estate market by purchasing bonds backed by mortgage pools. They come in various forms, including pass-through securities and CMOs, and play a significant role in enhancing liquidity and distributing risk in financial markets. Understanding MBS is crucial for any investor interested in fixed-income securities.
References
- Fabozzi, Frank J. “The Handbook of Mortgage-Backed Securities.” McGraw-Hill Education, 2016.
- Choudhry, Moorad. “Structured Credit Products: Credit Derivatives & Synthetic Securitisation.” John Wiley & Sons, 2004.
- “Mortgage-Backed Securities.” Investopedia, https://www.investopedia.com/terms/m/mbs.asp.
This comprehensive entry on Mortgage-Backed Securities (MBS) seeks to provide detailed and essential knowledge, unpacking one of the most significant components of modern financial markets.
