Mortgage-backed security

A mortgage-backed security (MBS) is a type of assetbacked security that is secured by a mortgage or collection of mortgages. The mortgages are 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. The mortgages of an
MBS may be residential or commercial, depending on
whether it is an Agency MBS or a Non-Agency MBS;
in the United States they may be issued by structures
set up by government-sponsored enterprises like Fannie
Mae or Freddie Mac, or they can be private-label, issued by structures set up by investment banks. The structure of the MBS may be known as pass-through, where
the interest and principal payments from the borrower or
homebuyer pass through it to the MBS holder, or it may Value of mortgage-backed security issuances in $USD trillions,
be more complex, made up of a pool of other MBSs. 1990-2009. (source: sifma statistics, structured nance)
Other types of MBS include collateralized mortgage obligations (CMOs, often structured as real estate mortgage
from banks and other lenders, and possibly assigned
investment conduits) and collateralized debt obligations
[1]
to a special purpose vehicle (SPV).
(CDOs).
The shares of subprime MBSs issued by various structures, such as CMOs, are not identical but rather issued as
tranches (French for slices), each with a dierent level
of priority in the debt repayment stream, giving them different levels of risk and reward. Tranchesespecially
the lower-priority, higher-interest tranchesof an MBS
are/were often further repackaged and resold as collaterized debt obligations.[2] These subprime MBSs issued
by investment banks were a major issue in the subprime
mortgage crisis of 20068.

2. The purchaser or assignee assembles these loans into

collections, or pools.
3. The purchaser or assignee securitizes the pools by
issuing mortgage-backed securities.
While a residential mortgage-backed security (RMBS) is
secured by single-family or two- to four-family real estate, a commercial mortgage-backed security (CMBS) is
secured by commercial and multi-family properties, such
as apartment buildings, retail or oce properties, hotels, schools, industrial properties, and other commercial
sites. A CMBS is usually structured as a dierent type of
security than an RMBS.

The total face value of an MBS decreases over time, because like mortgages, and unlike bonds, and most other
xed-income securities, the principal in an MBS is not
paid back as a single payment to the bond holder at maturity but rather is paid along with the interest in each periodic payment (monthly, quarterly, etc.). This decrease
in face value is measured by the MBSs factor, the percentage of the original face that remains to be repaid.

These securitization trusts may be structured by

government-sponsored enterprises as well as by private
entities that may oer credit enhancement features to
mitigate the risk of prepayment and default associated
with these mortgages. Since residential mortgage holders
in the United States have the option to pay more than
1 Securitization
the required monthly payment (curtailment) or to pay o
the loan in its entirety (prepayment), the monthly cash
The process of securitization is complex and depends ow of an MBS is not known in advance, and an MBS
greatly on the jurisdiction within which the process therefore presents a risk to investors.
is conducted. Among other things, securitization dis- In the United States, the most common securitization
tributes risk and permits investors to choose dierent lev- trusts are sponsored by Fannie Mae and Freddie Mac,
els of investment and risk.[3] The basics are:
US government-sponsored enterprises. Ginnie Mae, a
US government-sponsored enterprise backed by the full
1. Mortgage loans (mortgage notes) are purchased faith and credit of the US government, guarantees that
1

its investors receive timely payments but buys limited

numbers of mortgage notes. Some private institutions
also securitize mortgages, known as private-label mortgage securities.[4][5] Issuances of private-label mortgagebacked securities increased dramatically from 2001 to
2007 and then ended abruptly in 2008, when real estate markets began to falter.[6] An example of a privatelabel issuer is the real estate mortgage investment conduit
(REMIC), a tax-structure entity usually used for CMOs;
among other things, a REMIC structure avoids so-called
double taxation.[7]

1.1

Advantages and disadvantages

The securitization of mortgages in the 1970s had the advantage of providing more capital for housing at a time
when the demographic bulge of baby boomers created a
housing shortage and ination was undermining a traditional source of housing funding, the savings and loan associations (or thrifts), which were limited to providing
uncompetitive 5.75% interest rates on savings accounts
and consequently losing savers money to money market
funds. Unlike the traditional localized, inecient mortgage market where there might be a shortage or surplus
of funds at any one time, MBSs were national in scope
and regionally diversied.[8]

HISTORY

sponsored corporation Fannie Mae to create a liquid secondary market in these mortgages and thereby free up
the loan originators to originate more loans, primarily
by buying FHA-insured mortgages.[14] As part of the
Housing and Urban Development Act of 1968, Fannie
Mae was split into the current Fannie Mae and Ginnie
Mae to support the FHA-insured mortgages, as well as
Veterans Administration (VA) and Farmers Home Administration (FmHA) insured mortgages, with the full
faith and credit of the US government.[15] In 1970, the
federal government authorized Fannie Mae to purchase
private mortgagesthat is, those not insured by the FHA,
VA, or FmHA, and created Freddie Mac to perform a
role similar to that of Fannie Mae.[15] Ginnie Mae does
not invest in private mortgages.

2.2 Securitization

Ginnie Mae guaranteed the rst mortgage pass-through

security of an approved lender in 1968.[16] In 1971, Freddie Mac issued its rst mortgage pass-through, called a
participation certicate, composed primarily of private
mortgages.[16] In 1981, Fannie Mae issued its rst mortgage pass-through, called a mortgage-backed security.[17]
In 1983, Freddie Mac issued the rst collateralized mortHowever, mortgage-backed securities also lead inex- gage obligation.[18]
orably to the rise of the subprime industry and created
hidden, systemic risks. They also undid the connec- In 1960 the government enacted the Real Estate Investtion between borrowers and lenders. Historically, less ment Trust Act to allow the creation of the real estate
than 2% of people lost their homes to foreclosure, but investment trust (REIT) to encourage real estate investof America issued the rst priwith securitization, once a lender sold a mortgage, it no ment, and in 1977 Bank[19]
vate
label
pass-through.
In 1983 the Federal Reserve
longer had a stake in whether the borrower could make
[9]
Board
amended
Regulation
T to allow broker-dealers
his or her payments.
to use pass-throughs as margin collateral, equivalent to
over-the-counter non-convertible bonds.[20] In 1984 the
government passed the Secondary Mortgage Market En2 History
hancement Act to improve the marketability of private
label pass-throughs,[19] which declared nationally recogAmong the early examples of mortgage-backed securi- nized statistical rating organization AA-rated mortgageties in the United States were the farm railroad mortgage backed securities to be legal investments equivalent to
bonds of the mid-19th century which contributed to the Treasury securities and other federal government bonds
panic of 1857.[10] There was also an extensive commer- for federally charted banks (such as federal savings banks
and federal savings associations), state-chartered nancial MBS market in the 1920s.[11]
cial institutions (such as depository banks and insurance
companies) unless overridden by state law before Octo2.1 US government
ber 1991 (which 21 states did[21] ), and Department of
Laborregulated pension funds.[22]
As part of the New Deal following the Great Depression, The Tax Reform Act of 1986 allowed the creation of
the US federal government created the Federal Housing the tax-exempt real estate mortgage investment conduit
Administration (FHA) with the National Housing Act of (REMIC) special purpose vehicle for the express purpose
1934 to assist in the construction, acquisition, and reha- of issuing pass-throughs.[23] The Tax Reform Act signifbilitation of residential properties.[12] The FHA helped icantly contributed to the savings and loan crisis of the
develop and standardize the xed-rate mortgage as an al- 1980s and 1990s that resulted in the Financial Institutions
ternative to the balloon payment mortgage by insuring Reform, Recovery and Enforcement Act of 1989, which
them, and helped the mortgage design garner usage.[13]
dramatically changed the savings and loan industry and its
In 1938, the government also created the government- federal regulation, encouraging loan origination.[24][25]

2.3

Subprime mortgage crisis

Low-quality mortgage-backed securities backed by

subprime mortgages played a major role in the 200712
global nancial crisis. By 2012 the market for highquality mortgage-backed securities had recovered and
was a prot center for US banks.[26]

Types

A collateralized mortgage obligation, or paythrough bond, is a debt obligation of a legal entity that is collateralized by the assets it owns. Paythrough bonds are typically divided into classes
that have dierent maturities and dierent priorities for the receipt of principal and in some
cases of interest.[28] They often contain a sequential pay security structure, with at least two classes
of mortgage-backed securities issued, with one class
receiving scheduled principal payments and prepayments before any other class.[29] Pay-through securities are classied as debt for income tax purposes.[30]
A stripped mortgage-backed security (SMBS) where
each mortgage payment is partly used to pay down
the loans principal and partly used to pay the interest
on it. These two components can be separated to
create SMBSs, of which there are two subtypes:
An interest-only stripped mortgage-backed security (IO) is a bond with cash ows backed
by the interest component of property owners
mortgage payments.
A net interest margin security (NIMS)
is re-securitized residual interest of a
mortgage-backed security[31]
A principal-only stripped mortgage-backed security (PO) is a bond with cash ows backed by
the principal repayment component of property owners mortgage payments.

Most bonds backed by mortgages are classied as an

MBS. This can be confusing, because a security derived
from an MBS is also called an MBS. To distinguish
the basic MBS bond from other mortgage-backed instruments, the qualier pass-through is used, in the same way There are a variety of underlying mortgage classications
that vanilla designates an option with no special fea- in the pool:
tures.
Prime mortgages are conforming mortgages with
Subtypes of mortgage-backed security include:
prime borrowers, full documentation (such as verication of income and assets), strong credit scores,
etc.
Pass-through securities are issued by a trust and allocate the cash ows from the underlying pool to
Alt-A mortgages are an ill-dened category, generthe securities holders on a pro rata basis. A trust
ally prime borrowers but non-conforming in some
that issues pass-through certicates is taxed under
way, often lower documentation (or in some other
the grantor trust rules of the Internal Revenue Code.
way: vacation home, etc.)[32] Alt-A mortgages tend
Under these rules, the holder of a pass-through certo be larger in size than subprime loans and have
ticate is taxed as a direct owner of the portion of the
signicantly higher credit quality. For example, an
trust allocatable to the certicate. In order for the
Alt-A loan might be to an individual with multiissuer to be recognized as a trust for tax purposes,
ple and varying sources of income; non-owner octhere can be no signicant power under the trust
cupied, investment properties are often Alt-A loans.
agreement to change the composition of the asset
Because Alt-A loans are not conforming loans, they
pool or otherwise to reinvest payments received, and
are not eligible for purchase by Fannie Mae or Fredthe trust must have, with limited exceptions, only a
die Mac.[33]
single class of ownership interests.[27]
Subprime mortgages have weaker credit scores, no
verication of income or assets, etc.
A residential mortgage-backed security
(RMBS) is a pass-through MBS backed by
Jumbo mortgage when the size of the loan is bigger
mortgages on residential property.
than the conforming loan amount as set by Fannie
A commercial mortgage-backed security
Mae or Freddie Mac. As such, the mortgage rates
(CMBS) is a pass-through MBS backed by
on jumbo loans are somewhat higher than for conmortgages on commercial property.
forming loans.[33]

USES

These types are not limited to Mortgage Backed Securi- mortgage market, with volume in the trillions of dolties. Bonds backed by mortgages but that are not MBSs lars annually.[36] TBAs are traded by MBS traders with
can also have these subtypes.
notional amounts. There are settlement days when the
There are two types of classications based on the issuer traders have to make good on their trades. At that time,
they choose fractions from various pools to make up their
of the security:
TBA. Only agency mortgage-backed securities trade in
the TBA market.[36] In a TBA transaction, the parties
Agency, or government, issued securities by agree on a price for delivering a given volume of Agency
government-sponsored enterprise issuers, such as Pass-Through Mortgage-Backed Securities at a specied
Fannie Mae, Freddie Mac, and Ginnie Mae.
future date. The distinguishing feature of a TBA transaction is that the actual identity of the securities to be
Fannie Mae and Freddie Mac sell short term
delivered at settlement is not specied on the date of ex(36 month) bills at auction on a weekly
ecution (Trade Date). Instead, the parties to the trade
[34]
schedule,
and longer-term (110 year)
agree on only ve general parameters of the securities to
[35]
notes at monthly auctions.
be delivered: issuer, mortgage type, maturity, coupon,
The underlying mortgages for Agency MBS and month of settlement.[37]
are one to four-single family residential mortTBAs are critical in determining the ultimate interest
gages only.
rates that mortgage borrowers pay, since mortgage origi Non-agency, or private-label, securities by non- nators can lock in rates and use TBAs to hedge their exgovernmental issuers, such as trusts and other posure. TBAs are also used to hedge many non-TBA elispecial purpose entities like real estate mortgage in- gible mortgage products, such as hybrid ARMs and nonagency mortgages.[36]
vestment conduits.
The underlying mortgages for Non-Agency
MBS are backed by second mortgage loans, 3.3 Covered bonds
manufactured housing loans, and a variety of
commercial real estate loans, in addition to Main article: covered bond
single family residential mortgages.

3.1

Secondary mortgage market

The secondary mortgage market is the market where a

network of lenders sell, and investors buy, existing mortgages or MBS. A large percentage of newly originated
mortgages are sold by their originators into this large and
liquid market where they are packaged into MBS and sold
to public and private investors, including Fannie Mae,
Freddie Mac, pension funds, insurance companies, mutual funds and hedge funds.

In Europe there exists a type of asset-backed bond called

a covered bond, commonly known by the German term
Pfandbriefe. Covered bonds were rst created in 19thcentury Germany when Frankfurter Hypo began issuing
mortgage covered bonds. The market has been regulated
since the creation of a law governing the securities in
Germany in 1900. The key dierence between covered
bonds and mortgage-backed or asset-backed securities is
that banks that make loans and package them into covered bonds keep those loans on their books. This means
that when a company with mortgage assets on its books
issues the covered bond, its balance sheet grows, which
would not occur if it issued an MBS, although it may still
guarantee the securities payments.

Because of the long-term nature of mortgages, the secondary market is an essential factor in maintaining lender
liquidity. The infusion of capital from investors provides
mortgage lenders such as banks, thrifts, mortgage bankers
and other loan originators with a market for their loans. In
4 Uses
addition to providing liquidity and increasing overall eciency, the secondary market can smooth out geographic
credit disparities. However, in some respects, particu- There are many reasons for mortgage originators to larly where subprime and other riskier mortgages are in- nance their activities by issuing mortgage-backed securivolved, the secondary mortgage market may exacerbate ties. Mortgage-backed securities:
certain risks and volatility.[3]
1. transform relatively illiquid, individual nancial assets into liquid and tradable capital market instru3.2 TBAs
ments
TBAsshort for to-be-announced securitiesinvolve
a special type of trading of mortgage-backed securities. TBAs are the most liquid and important secondary

2. allow mortgage originators to replenish their funds,

which can then be used for additional origination activities

5
risky capital structures and allowing credit risk underpricing. Obalance sheet securitizations are believed to
have played a large role in the high leverage ratio of US
nancial institutions before the nancial crisis.[39]

6 Market size and liquidity

Risk, Return, Rating & Yield relate

As of the second quarter of 2011, there was about $13.7

trillion in total outstanding US mortgage debt.[40] There
were about $8.5 trillion in total US mortgage-related
securities.[41] About $7 trillion of that was securitized
or guaranteed by government-sponsored enterprises or
government agencies, the remaining $1.5 trillion being
pooled by private mortgage conduits.[40]

According to the Bond Market Association, gross US is3. can be used by Wall Street banks to monetize the
suance of agency MBS was (see also chart above):
credit spread between the origination of an underlying mortgage (private market transaction) and the
2005: USD 0.967 trillion
yield demanded by bond investors through bond issuance (typically a public market transaction)
2004: USD 1.019 trillion
4. are often a more ecient and lower-cost source of
2003: USD 2.131 trillion
nancing in comparison with other bank and capital
markets nancing alternatives.
2002: USD 1.444 trillion
5. allow issuers to diversify their nancing sources by
oering alternatives to more traditional forms of
debt and equity nancing

2001: USD 1.093 trillion

6. allow issuers to remove assets from their balance 7 Pricing

sheet, which can help to improve various nancial
ratios, utilize capital more eciently, and achieve 7.1 Valuation
compliance with risk-based capital standards
The weighted-average maturity (WAM) and weighted avThe high liquidity of most mortgage-backed securities erage coupon (WAC) are used for valuation of a passmeans that an investor wishing to take a position need not through MBS, and they form the basis for computing cash
deal with the diculties of theoretical pricing described ows from that mortgage pass-through. Just as this artibelow; the price of any bond is essentially quoted at fair cle describes a bond as a 30-year bond with 6% coupon
rate, this article describes a pass-through MBS as a $3
value, with a very narrow bid/oer spread.
billion pass-through with 6% pass-through rate, a 6.5%
Reasons (other than investment or speculation) for enterWAC, and 340-month WAM. The pass-through rate is
ing the market include the desire to hedge against a drop
dierent from the WAC; it is the rate that the investor
in prepayment rates (a critical business risk for any comwould receive if he/she held this pass-through MBS, and
pany specializing in renancing).
the pass-through rate is almost always less than the WAC.
The dierence goes to servicing costs (i.e., costs incurred
in collecting the loan payments and transferring the pay5 Criticisms
ments to the investors.)
Critics have suggested that the complexity inherent in securitization can limit investors ability to monitor risks,
and that competitive securitization markets with multiple
securitizers may be particularly prone to sharp declines
in underwriting standards. Private, competitive mortgage
securitization is believed to have played an important role
in the US subprime mortgage crisis.[38] In addition, o
balance sheet treatment for securitizations coupled with
guarantees from the issuer are said to make the securitizing rms leverage less transparent, thereby facilitating

To illustrate these concepts, consider a mortgage pool

with just three mortgage loans that have the following outstanding mortgage balances, mortgage rates, and months
remaining to maturity:
7.1.1 Weighted-average maturity
The weighted-average maturity (WAM) of a pass-through
MBS is the average of the maturities of the mortgages in
the pool, weighted by their balances at the issue of the

7 PRICING

MBS. Note that this is an average across mortgages, as

distinct from concepts such as weighted-average life and
duration, which are averages across payments of a single
loan.

to occur when oating rates drop and the xed income of

the bond would be more valuable (negative convexity).
In other words, the proceeds received would need to be
reinvested at a lower interest rate.[7] Hence the term preThe weightings are computed by dividing each outstand- payment risk.
ing loan amount by total amount outstanding in the mort- Professional investors generally use arbitrage-pricing
gage pool (i.e., $900,000). These amounts are the out- models to value MBS. These models deploy interest
standing amounts at the issuance or initiation of the MBS. rate scenarios consistent with the current yield curve as
The WAM for the above example is computed as follows: drivers of the econometric prepayment models that modWAM = (22.22% 300) + (44.44% 260) + (33.33% els homeowner behavior as a function of projected mortgage rates. Given the market price, the model produces
280) = 66.66 + 115.55 + 93.33 = 275.55 months
an option-adjusted spread, a valuation metric that takes
into account the risks inherent in these complex securities. [44]
7.1.2 Weighted-average coupon
There are other drivers of the prepayment function (or
The weighted-average coupon (WAC) of a pass-through
prepayment risk), independent of the interest rate, such
MBS is the average of the coupons of the mortgages in the
as:
pool, weighted by their original balances at the issuance
of the MBS. For the above example this is:
economic growth, which is correlated with increased
WAC = (22.22% 6.00%) + (44.44% 6.25%) +
turnover in the housing market
(33.33% 6.50%) = 1.33% + 2.77% + 2.166% =
6.277%
home prices ination

7.2

Theoretical pricing

unemployment

regulatory risk (if borrowing requirements or tax

laws in a country change this can change the marPricing a vanilla corporate bond is based on two sources
ket profoundly)
of uncertainty: default risk (credit risk) and interest rate
(IR) exposure.[42] The MBS adds a third risk: early re demographic trends, and a shifting risk aversion prodemption (prepayment). The number of homeowners
le, which can make xed rate mortgages relatively
in residential MBS securitizations who prepay increases
more or less attractive
when interest rates decrease. One reason for this phenomenon is that homeowners can renance at a lower
xed interest rate. Commercial MBS often mitigate this
7.2.2 Credit risk
risk using call protection.[43]
Since these two sources of risk (IR and prepayment) are
linked, solving mathematical models of MBS value is a
dicult problem in nance. The level of diculty rises
with the complexity of the IR model and the sophistication of the prepayment IR dependence, to the point that
no closed-form solution (i.e., one that could be written
down) is widely known. In models of this type, numerical
methods provide approximate theoretical prices. These
are also required in most models that specify the credit
risk as a stochastic function with an IR correlation. Practitioners typically use specialised Monte Carlo methods
or modied Binomial Tree numerical solutions.
7.2.1

Interest rate risk and prepayment risk

Theoretical pricing models must take into account the

link between interest rates and loan prepayment speed.
Mortgage prepayments are usually made because a home
is sold or because the homeowner is renancing to a new
mortgage, presumably with a lower rate or shorter term.
Prepayment is classied as a risk for the MBS investor despite the fact that they receive the money, because it tends

Main article: Credit risk

The credit risk of mortgage-backed securities depends on
the likelihood of the borrower paying the promised cash
ows (principal and interest) on time. The credit rating
of MBS is fairly high because:
1. Most mortgage originations include research on the
mortgage borrowers ability to repay, and will try to
lend only to the creditworthy. An important exception to this is no-doc or low-doc loans.
2. Some MBS issuers, such as Fannie Mae, Freddie
Mac, and Ginnie Mae, guarantee against homeowner default risk. In the case of Ginnie Mae, this
guarantee is backed with the full faith and credit of
the US federal government.[45] This is not the case
with Fannie Mae and Freddie Mac, but these two entities have lines of credit with the US federal government; however, these lines of credit are extremely
small compared to the average amount of money circulated through these entities in one days business.

7
Additionally, Fannie Mae and Freddie Mac generally require private mortgage insurance on loans in
which the borrower provides a down payment that is
less than 20% of the property value.

The price of an MBS pool is inuenced by prepayment

speed, usually measured in units of CPR or PSA. When
a mortgage renances or the borrower prepays during the
month, the prepayment measurement increases.

3. Pooling many mortgages with uncorrelated default

probabilities creates a bond with a much lower probability of total default, in which no homeowners are
able to make their payments (see Copula). Although
the risk neutral credit spread is theoretically identical between a mortgage ensemble and the average
mortgage within it, the chance of catastrophic loss
is reduced.

If the lovina acquired a pool at a premium (>100), as is

common for higher coupons, then they are at risk for prepayment. If the purchase price was 105, the investor loses
5 cents for every dollar prepaid, which may signicantly
decrease the yield. This is likely to happen as holders of
higher-coupon MBSs have a good incentive to renance.

4. If the property owner should default, the property remains as collateral. Although real estate prices can
move below the value of the original loan, this increases the solidity of the payment guarantees and
deters borrower default.
If the MBS was not underwritten by the original real estate and the issuers guarantee, the rating of the bonds
would be much lower. Part of the reason is the expected
adverse selection against borrowers with improving credit
(from MBSs pooled by initial credit quality) who would
have an incentive to renance (ultimately joining an MBS
pool with a higher credit rating).

7.3

Real-world pricing

Because of the diversity in MBS types, there is wide variety of pricing sources. In general, the more uniform or
liquid the MBS, the greater the transparency or availability of prices.[36] Most traders and money managers use
Bloomberg and Intex to analyze MBS pools and more esoteric products such as CDOs, although tools such as Citis
The Yield Book and Barclays POINT are also prevalent
across Wall Street, especially for multiasset class managers. Some institutions have also developed their own
proprietary software. Tradeweb is used by the largest
bond dealers (the primaries) to transact round lots ($1
million and larger).

Conversely, it may be advantageous to the bondholder for

the borrower to prepay if the low-coupon MBS pool was
bought at a discount (<100). This is due to the fact that
when the borrower pays back the mortgage, he does so
at par. So if the investor bought a bond at 95 cents
on the dollar, as the borrower prepays he or she gets the
full dollar back and his or her yield increases. However,
this is unlikely to happen, as borrowers with low-coupon
mortgages have very little incentive to renance.
The price of an MBS pool is also inuenced by the loan
balance. Common specications for MBS pools are loan
amount ranges that each mortgage in the pool must pass.
Typically, high-premium (high-coupon) MBSs backed by
mortgages with an original loan balance no larger than
$85,000 command the largest pay-ups. Even though the
borrower is paying an above market yield, he or she is
dissuaded from renancing a small loan balance due to
the high xed cost involved.
Low Loan Balance: < $85,000
Mid Loan Balance: $85,000$110,000
High Loan Balance: $110,000$150,000
Super High Loan Balance: $150,000$175,000
TBA: > $175,000

The plurality of factors makes it dicult to calculate the

value of an MBS security. Often market participants do
not concur, resulting in large dierences in quoted prices
for the same instrument. Practitioners constantly try to
improve prepayment models and hope to measure values for input variables implied by the market. Varying
liquidity premiums for related instruments and changing
Complex structured products tend to trade less frequently liquidity over time make this a dicult task. One facand involve more negotiation. Prices for these more com- tor used to express price of an MBS security is the pool
plicated MBSs, as well as for CMOs and CDOs, tend to factor.
be more subjective, often available only from dealers.[36]
For vanilla or generic 30-year pools (FN/FG/GN)
with coupons of 3.5%7%, one can see the prices posted
on a TradeWeb screen by the primaries called To Be Allocated (TBA). This is due to the actual pools not being
shown. These are forward prices for the next 3 delivery
months since pools have not been cut; only the issuing
agency, coupon, and dollar amount are revealed. A specic pool whose characteristics are known would usually
trade TBA plus {x} ticks or a pay-up, depending on
characteristics. These are called specied pools, since
the buyer species the pool characteristic he/she is willing
to pay up for.

8 Recording and Mortgage Electronic Registration Systems

One critical component of the securitization system in
the US market is the Mortgage Electronic Registration
Systems (MERS) created in the 1990s, which created a
private system wherein underlying mortgages were assigned and reassigned outside of the traditional countylevel recording process. The legitimacy and overall accuracy of this alternative recording system have faced seri-

10

ous challenges with the onset of the mortgage crisis: as

the US courts ood with foreclosure cases, the inadequacies of the MERS model are being exposed, and both local and federal governments have begun to take action
through suits of their own and the refusal (in some jurisdictions) of the courts to recognize the legal authority
of MERS assignments.[46][47] The assignment of mortgage (deed of trust) and note (obligation to pay the debt)
paperwork outside of the traditional US county courts
(and without recordation fee payment) is subject to legal challenge. Legal inconsistencies in MERS originally
appeared trivial, but they may reect dysfunctionality in
the entire US mortgage securitization industry.

REFERENCES

[13] Fabozzi & Modigliani 1992, p. 19.

[14] Fabozzi & Modigliani 1992, pp. 1920.
[15] Fabozzi & Modigliani 1992, p. 20.
[16] Fabozzi & Modigliani 1992, p. 21.
[17] Fabozzi & Modigliani 1992, p. 23.
[18] Fabozzi & Modigliani 1992, p. 25.
[19] Fabozzi & Modigliani 1992, p. 31.
[20] Fabozzi & Modigliani 1992, p. 34.

A notes

[21] The 21 states that utilized the exemption provisions were

Alaska, Arkansas, Colorado, Connecticut, Delaware,
Florida, Georgia, Illinois, Kansas, Maryland, Michigan,
Missouri, Nebraska, New Hampshire, New York, North
Carolina, Ohio, South Dakota, Utah, Virginia, and West
Virginia.

Bank of America Home Loans

[22] Fabozzi & Modigliani 1992, p. 32.

Dollar roll

[23] Fabozzi & Modigliani 1992, pp. 3334.

New Century

[24] Cebula, Richard J.; Hung, Chao-shun (1992). The Savings

and Loan Crisis. p. 57. ISBN 978-0-8403-7620-6. The
Tax Reform Act of 1986 signicantly acted to reduce real
estate values and to weaken the prot positions of Savings
and Loans...

See also

United States housing bubble

10

References

[1] Lemke, Lins and Picard, Mortgage-Backed Securities,

Chapters 4 and 5 (Thomson West, 2013 ed.).
[2] How can mortgage-backed securities bring down the U.S.
economy?| Josh Clark| How Stu Works
[3] Lemke, Lins and Picard, Mortgage-Backed Securities,
Chapter 1 (Thomson West, 2013 ed.).
[4] Mortgage-Backed securities. U.S. Securities and Exchange Commission.

[25] Fabozzi & Modigliani 1992, p. 26.

[26] Peter Eavis (August 8, 2012). With Rates Low, Banks
Increase Mortgage Prot (Dealbook blog). The New York
Times. Retrieved August 9, 2012.
[27] Trust must satisfy the restrictions of Treas. Reg.
301.7701-4(c) to prevent recharacterization of the trust
as a business entity for tax purposes.
[28] Joseph G. Haubrich, Derivative Mechanics: The CMO,
Economic Commentary, Federal Reserve Bank of Cleveland, Issue Q I, pages 13-19, (1995).

[5] Risk Glossary.

[29] These securities are referred to as Fast-pay, Slow-pay securities.

[6] The Budget and Economic Outlook: Fiscal Years 2010

to 2020 - CBO. Cbo.gov. 2010-01-26. Retrieved 201408-23.

[30] IRC 385.

[7] Lemke, Lins and Picard, Mortgage-Backed Securities,

Chapter 4 (Thomson West, 2013 ed.).
[8] All the Devils Are Here, MacLean and Nocera, p.5
[9] All the Devils Are Here, MacLean and Nocera, p.19
[10] ""Dj Vu All Over Again: Agency, Uncertainty, Leverage and the Panic of 1857, Timothy J. Riddiough
and Howard E. Thompson, 2012. Papers.ssrn.com.
doi:10.2139/ssrn.2042316. Retrieved 2014-08-23.
[11] Securitization in the 1920s. Nber.org. Retrieved 201408-23.
[12] Fabozzi & Modigliani 1992, pp. 1819.

[31] Keith L. Krasney, Legal Structure of Net Interest

Margin Securities, The Journal of Structured Finance,
Spring 2007, Vol.
13, No.
1: pp.
54-59,
doi:10.3905/jsf.2007.684867
[32] A Journey to the Alt-A Zone: A Brief Primer on AltA Mortgage Loans (PDF). Nomura Fixed Income Research.
[33] Lemke, Lins and Picard, Mortgage-Backed Securities,
Chapter 3 (Thomson West, 2013 ed.).
[34] Fannie Mae, Freddie Mac 2013 bill sale calendar.
Reuters. Retrieved 11 January 2013.
[35] Freddie Mac, Fannie Mae and FHLB 2013 note calendar. Reuters. Retrieved 11 January 2013.

[36] Lemke, Lins and Picard, Mortgage-Backed Securities,

Chapter 5 (Thomson West, 2013 ed.).

More Mortgage Madness by Kai Wright, The Nation, April 29, 2009

[37] Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Proposed Rule
Change Relating to Post-Trade Transparency for Agency
Pass-Through Mortgage-Backed Securities Traded TBA
(PDF). SEC.

MBS Basics by Mortgage News Daily, MBS Commentary

[38] Michael Simkovic, Competition and Crisis in Mortgage Securitization

[39] Michael Simkovic, Secret Liens and the Financial Crisis
of 2008, American Bankruptcy Law Journal, Vol. 83, p.
253, 2009
[40] Federal Reserve Statistical Release. Federalreserve.gov.
2009-03-27. Retrieved 2014-08-23.
[41] Securities Industry and Financial Markets Association
Statistical Release Archived April 19, 2009 at the
Wayback Machine
[42] Ross, Stephen A.; et al. (2004). Essentials of Corporate
Finance, Fourth Edition. McGraw-Hill/Irwin. pp. 158,
186. ISBN 0-07-251076-5.
[43] LaCour-Little, Michael. Call Protection In Mortgage
Contracts (PDF). AREUEA. p. 2. Retrieved 30 November 2012.
[44] Hayre 2001, p. 29.
[45] Mortgage-backed securities are oering decent returns.
USA Today. October 21, 2010.
[46] Archived November 25, 2011 at the Wayback Machine
[47] HSBC Bank USA, N.A. v Taher (2011 NY Slip Op
51208(U))". Nycourts.gov. Retrieved 2014-08-23.

11

Bibliography

Lemke, Thomas P.; Lins, Gerald T.; Picard, Marie

E. (2013). Mortgage-Backed Securities. Thomson
West.
Fabozzi, Frank J.; Modigliani, Franco (1992).
Mortgage and Mortgage-backed Securities Markets.
Harvard Business School Press. ISBN 0-87584322-0.
Hayre, Lakhbir (2001). Salomon Smith Barney
Guide to Mortgage-Backed and Asset-Backed Securities. Wiley. ISBN 978-0-471-38587-5.

12

External links

Vink, Dennis and Thibeault, Andr (2008). ABS,

MBS and CDO Compared: An Empirical Analysis
The Journal of Structured Finance

http://www.slate.com/articles/news_and_politics/
explainer/2008/03/what_is_a_mortgagebacked_
security.html] What Is a Mortgage-Backed Security? by Chris Wilson, in Slate Magazine
TBA Trading and Liquidity in the Agency MBS
Market, by the Federal Reserve Bank of New York

10

13

13
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