Mortgage-Backed Securities (MBS)

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Mortgage-backed securities (MBS) are pools of mortgages packaged as collateral and sold as securities in the secondary mortgage market. The creation of these securities is credited to the Government National Mortgage Association [1] (Ginnie Mae), a wholly-owned federal corporation within the U.S. Department of Housing and Urban Development (HUD) [2]. The MBS program was designed to increase the supply of funds available for home mortgages. This is achieved by allowing banks and other mortgage lenders to sell portfolios of existing home mortgage loans (i.e., mortgage-backed securities). The product can be sold as one or more whole securities to large institutional investors, or purchased by small investors as shares of popular Ginnie Mae MBS mutual funds

MBSs made a small splash in 1968 when they first were issued, and today are at the heart of a billion dollar securitization industry. MBSs are called "pass-through" certificates. The monthly principal and interest payment from each of the underlying mortgage loans is "passed through" to investors. The interest rate of the security is lower than the interest rate of the underlying loan to allow for payment of servicing and guaranty fees. By selling a pool of mortgage loans to an MBS servicer, the lender receives funds equal to the underlying value of the pool, which will be used to make more home mortgage loans.

MBS have garnered controversy for their role in subprime lending. MBS allow originating banks to offload their exposures to homeowners to the bond market, recycling their capital so they can originate more mortgages. Investors count on the investment banks and, crucially, the rating agencies to rate and then monitor the credit quality of the resulting MBS. Apparently compromised by their reliance on this flow of business, however, the agencies and investment banks failed to spot (or, say some, deliberately ignored) the deteriorating underwriting standards of the originating banks, and rated as triple-A (AAA to Standard & Poor's and Fitch, Aaa to Moody's Corporation) some MBS that were, in fact, much riskier. This mistake was compounded by the emergence of CDO's (Collateralized Debt Obligations) that invested in these MBS on the basis of their ratings, and got their own AAA/Aaa ratings on their bonds as a result.

Whether the resulting meltdown was the result of corruption, or simply incompetence, is still under debate. The rating agencies, not without some reason, can claim to have been duped alongside the investors -- to have lost 'reputation capital' just as the investors lost money capital. Many observers, though, point to the enormous growth in their business on the back of the securitization phenomenon.

While highly visible and distressing, subprime MBS and CDOs are only a fraction of the securitization market; many MBS are still considered high-grade either because of the high credit quality of the mortgage pools that back them, or because of the guarantee of the federal housing agencies. Securitization remains a pillar of all modern capital markets because of its ability to move risk onto the balance sheets of investors and creditors who are better able to bear that risk than the originating institutions.

See especially Government National Mortgage Association, [3] Ginnie Mae, or GNMA.