Definition
Mortgage bonds are a type of secured debt instrument that is specifically backed by a pool of mortgages on real estate assets. Unlike bonds secured by other collateral such as equipment or inventory, mortgage bonds are considered relatively safer as the underlying real estate is generally more stable in value.
Types of Mortgage Bonds
First Mortgage Bonds
First mortgage bonds are secured by a first lien on the mortgaged property, meaning that in the event of default, these bondholders have the first claim to the collateral.
Second Mortgage Bonds
Second mortgage bonds are backed by a second lien, giving these bondholders a subordinate claim on the property after the first mortgage bondholders.
Collateralized Mortgage Obligations (CMOs)
CMOs are complex types of mortgage bonds that divide the mortgage pool into tranches, providing different levels of risk and return for investors.
Historical Context
The concept of mortgage bonds dates back to the late 19th and early 20th centuries, primarily in European countries such as Germany and the United Kingdom. They became more widespread in the United States after the Great Depression, as a means to provide safer investment options and stabilize the banking and housing sectors.
Practical Implications
Risk and Return
Mortgage bonds generally offer lower yields compared to unsecured debt instruments due to their lower risk profile. The value of these bonds is tied to the performance of the underlying real estate assets.
Market Liquidity
Mortgage bonds are often traded in secondary markets, providing investors with the ability to buy and sell these instruments before maturity. However, their liquidity can be lower than that of unsecured bonds, especially during times of economic downturn.
Applicability
Mortgage bonds are commonly issued by real estate and financial institutions looking to raise capital. They are suitable for investors seeking a stable income with lower default risk, such as insurance companies, pension funds, and individual investors looking for conservative investment options.
Comparisons and Related Terms
Equipment Trust Certificates (ETCs)
While mortgage bonds are secured by real estate, ETCs are backed by equipment such as airplanes and railroad cars. Mortgage bonds generally have a lower risk profile compared to ETCs due to the typically higher and more stable value of real estate.
Covered Bonds
Covered bonds are similar to mortgage bonds but offer additional protection to investors through a “cover pool” of assets beyond the mortgages themselves. They are more prevalent in Europe than in the United States.
FAQs
Q: Are mortgage bonds the same as mortgage-backed securities (MBS)?
Q: How do interest rates affect mortgage bonds?
Q: What are the risks associated with mortgage bonds?
References
- Fabozzi, F. J. (2001). The Handbook of Mortgage-Backed Securities (6th ed.). McGraw-Hill Education.
- Mishkin, F. S. (2015). The Economics of Money, Banking, and Financial Markets (11th ed.). Pearson.
- Gorton, G. B. (2010). Slapped by the Invisible Hand: The Panic of 2007. Oxford University Press.
Summary
Mortgage bonds are secured debt instruments backed by real estate, providing lower risk and stable returns for investors. Originating in the late 19th century, they have evolved into a crucial part of financial markets, particularly for institutions seeking safe investment strategies. While they differ from other forms of secured and unsecured debt, their relative safety makes them an attractive option in diverse investment portfolios.
