Lecture

Mortgage-Backed Securities: Understanding Their Structure and Risks

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Description

This lecture provides an in-depth analysis of the US mortgage-backed securities (MBS) market, focusing on both agency and non-agency MBS. It begins with an overview of the historical context and the role of government-sponsored enterprises like Fannie Mae and Freddie Mac in guaranteeing credit risk. The instructor discusses the significant growth of MBS since the 1970s, highlighting that about two-thirds of residential mortgages are now securitized. The lecture explains the different types of MBS, including pass-through securities and collateralized mortgage obligations (CMOs), detailing how cash flows are structured to appeal to various investor segments. The risks associated with agency MBS, primarily interest rate risk, and the additional credit risks in non-agency MBS are thoroughly examined. The lecture also touches on the concept of credit enhancement and the importance of structuring in reallocating risk. Finally, the instructor contrasts the MBS market with the covered bond system in Switzerland, providing insights into why MBS have not gained traction in that country.

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Finance: Investment management

Related concepts (32)

Mortgage-backed security

A mortgage-backed security (MBS) is a type of asset-backed security (an 'instrument') which is secured by a mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals (a government agency or investment bank) that securitizes, or packages, the loans together into a security that investors can buy. Bonds securitizing mortgages are usually treated as a separate class, termed residential; another class is commercial, depending on whether the underlying asset is mortgages owned by borrowers or assets for commercial purposes ranging from office space to multi-dwelling buildings.

Asset-backed security

An asset-backed security (ABS) is a security whose income payments, and hence value, are derived from and collateralized (or "backed") by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets which are unable to be sold individually. Pooling the assets into financial instruments allows them to be sold to general investors, a process called securitization, and allows the risk of investing in the underlying assets to be diversified because each security will represent a fraction of the total value of the diverse pool of underlying assets.

Securitization

Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing.

Subprime mortgage crisis

The United States subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010 that contributed to the 2007–2008 global financial crisis. The crisis led to a severe economic recession, with millions of people losing their jobs and many businesses going bankrupt. The U.S. government intervened with a series of measures to stabilize the financial system, including the Troubled Asset Relief Program (TARP) and the American Recovery and Reinvestment Act (ARRA).

Mortgage loan

A mortgage loan or simply mortgage (ˈmɔɹɡɪdʒ), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any purpose while putting a lien on the property being mortgaged. The loan is "secured" on the borrower's property through a process known as mortgage origination.

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