An asset-backed security that is backed with a mortgage or a group of mortgages. The investment is secured by a collection of mortgages acquired from the banks or financial institutions that issued them. They are bought and sold on the bond market.
Investors in MBS are essentially lending money to home buyers.
Mortgages are aggregated and sold to a government entity or investment bank. The loans are then securitized, packaged, and sold to investors as securities. The bonds can be sold as residential or commercial, depending upon what type of real estate the mortgages are tied to that make up the bonds.
These are often "pass through" assets. That means that all payments, both principal and interest, from the homeowner pass through the banks and go to the holders of the MBS. This can get more complicated in the case of pools of MBS.
Mortgage bonds and MBS differ in the fact that the latter is made up of pieces from many mortgages. These are issued tranches, each with a separate repayment schedule along with varying credit risk. Tranches of lower priority, higher interest tend to be repackaged and sold against as collateralized debt obligation (CDOs).
Another difference is that a bond will maintain its face value throughout its life. With a MBS, since payments are made either monthly or quarterly, there is on one-time payment to cash out like with a bond. This means the face value of the MBS is constantly declining with the passage of time.
History
Mortgage-backed securities (MBS) are a type of financial instrument that are created by pooling together a group of mortgages and then selling securities that are backed by the cash flows from those mortgages. The history of mortgage-backed securities can be traced back to the 19th century; however, it was not until the 1970s and 1980s that the modern MBS market truly took off.
The concept of securitizing mortgages dates back to the 1800s when private investors began buying and selling mortgage loans in the secondary market. These early mortgage-backed securities were relatively small and limited in scope. The modern MBS market began to take shape in the 1960s and 1970s with the introduction of government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac. These GSEs began buying and securitizing mortgages, creating a standardized process for pooling mortgages and issuing securities. This helped to reduce the risk and uncertainty associated with mortgage lending.
In the 1980s, private financial institutions began issuing their own mortgage-backed securities, known as private-label MBS. These securities were often more complex and risky than those issued by the GSEs and were targeted at institutional investors such as pension funds and insurance companies. The MBS market continued to expand and innovate throughout the 1990s and 2000s, with new types of MBS being created, such as collateralized debt obligations (CDOs) and mortgage-backed bonds (MBBs). These new types of MBS allowed investors to take on different levels of risk and return.
However, the MBS market played a central role in the 2008 Great Financial Crisis. Many MBS were tied to subprime mortgages, which were given to borrowers with poor credit histories and little ability to repay their loans. When the housing market collapsed, many of these borrowers defaulted on their loans, causing massive losses for investors and contributing to the worst financial crisis since the Great Depression.
In the wake of the financial crisis, regulators implemented new rules and regulations aimed at reducing risk and increasing transparency in the MBS market. These reforms included new disclosure requirements, risk retention rules, and stress testing for financial institutions.
Today, the MBS market remains an important source of funding for the housing market, but it is subject to greater scrutiny and regulation than in the past. As the housing market continues to recover, the MBS market is likely to play an increasingly important role in providing financing for homebuyers and investors. Despite the challenges of the past, the MBS market continues to evolve and adapt, offering a range of opportunities and risks for investors.
Major Institutions
Several Wall Street institutions were heavily involved with the mortgage-backed security (MBS) business. Here are some of the key players:
- Salomon Brothers: Salomon Brothers was one of the first Wall Street firms to aggressively enter the MBS market. The firm began buying and selling mortgage-backed securities in the 1970s, and was a pioneer in developing new financial instruments such as collateralized mortgage obligations (CMOs) in the 1980s.
- Bear Stearns: Bear Stearns was another early entrant into the MBS market. The firm began buying and selling mortgage-backed securities in the 1970s, and was known for its expertise in structuring and trading complex financial instruments.
- Lehman Brothers: Lehman Brothers was a major player in the MBS market, and was one of the largest underwriters of mortgage-backed securities in the years leading up to the 2008 financial crisis.
- Goldman Sachs: Goldman Sachs was also a significant player in the MBS market, and was known for its expertise in structuring and trading complex financial instruments.
- Merrill Lynch: Merrill Lynch was another Wall Street firm that was active in the MBS market. The firm was known for its expertise in securitizing and trading mortgage-backed securities.
- JPMorgan Chase: JPMorgan Chase was also involved in the MBS market, and was one of the largest underwriters of mortgage-backed securities in the years leading up to the 2008 financial crisis.
These Wall Street institutions played a key role in the growth and development of the MBS market. They helped to create a liquid and efficient market for mortgage-backed securities, and played a critical role in providing financing for the housing market. However, many of these firms were also heavily exposed to subprime mortgages and other risky assets, which contributed to the financial crisis of 2008.