Wednesday, July 15, 2009

mortgage backed securities

perhaps the most important innovation that occurred in residential mortgage markets since world war II was the development of the market for mortgage-backed securities (MBSs). pass-through MBSs are created bu pooling a group of similar mortgages. the owner then uses the mortgage pool as collateral for the issuance of a new security- the MBS. for example,a mortgage banker assembles a $100 million pool of 7.5 percent,30-year, level-payment mortgages. the mortgage banker then sells an undivided interest, or participation, in the mortgage pool to many investors who are promised an 7 present rate of interest on their invested capital. the issuer continues to service the underlying mortgages, collecting payment from borrowers and "passing through" to each security holder(1)its pro rate (proportionate) share of any principal repayments on the underlying mortgages and (2) 7 percent interest on its share of any outstanding principal that the issuer of the MBS has not returned to the investors. the difference between the 7.5 percent rate on the underlying mortgages and the 7 percent rate paid to investors is kept by the MBS issuer. This "spread" must cover the issuer is issuance and servicing costs. and the costs of absorbing the default risk in the pool of mortgages. when a mortgage is used as collateral for the issuance of a MBS, the underlying mortgage is said to be "securitized." Agencies and private companies that pool mortgage and sell MBSs are sometimes called conduits.
between one-half and two-thirds of all residential mortgage loans originated in the United states are now sold into the secondary mortgage market and used as collateral for the issuance of mortgage-backed securities. this securitization of pools of standardized residential mortgage has greatly increased the liquidity and efficiency of the mortgage market. By attracting nontraditional investors, such as pension funds, life insurance companies, and mutual funds, MBSs have brought many new sources of investment capital into the residential mortgage market.

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