Loading the player...
A:

Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security.

A typical example of securitization is a mortgage-backed security (MBS), which is a type of asset-backed security that is secured by a collection of mortgages. The process works as follows:

First, a regulated and authorized financial institution originates numerous mortgages, which are secured by claims against the various properties the mortgagors purchase. Then, all of the individual mortgages are bundled together into a mortgage pool, which is held in trust as the collateral for an MBS. The MBS can be issued by a third-party financial company, such a large investment banking firm, or by the same bank that originated the mortgages in the first place. Mortgage-backed securities are also issued by aggregators such as Fannie Mae or Freddie Mac.

Regardless, the result is the same: a new security is created, backed up by the claims against the mortgagors' assets. This security can be sold to participants in the secondary mortgage market. This market is extremely large, providing a significant amount of liquidity to the group of mortgages, which otherwise would have been quite illiquid on their own. (For a one-stop shop on subprime mortgages, the secondary market and the subprime meltdown, check out the Subprime Mortgages Feature.)

Furthermore, at the time the MBS is being created, the issuer will often choose to break the mortgage pool into a number of different parts, referred to as tranches. These tranches can be structured in virtually any way the issuer sees fit, allowing the issuer to tailor a single MBS for a variety of risk tolerances. Pension funds will typically invest in high-credit rated mortgage-backed securities, while hedge funds will seek higher returns by investing in those with low credit ratings.

For more on structured finance, check out Profit From Mortgage Debt With MBS.

RELATED FAQS
  1. What role did securitization play in the U.S. subprime mortgage crisis?

    Learn how the securitization of sub-prime mortgages into asset-backed securities fueled the real estate market crash in 2 ... Read Answer >>
  2. What's the difference between a collateralized mortgage obligation (CMO) and a mortgage-backed ...

    Find out more about collateralized mortgage obligations and mortgage-backed securities and the difference between the two ... Read Answer >>
  3. What do mortgage lenders use the securitization food chain?

    Read about the origins of Chris Ferguson's securitization food chain, and find out how mortgage lenders could package and ... Read Answer >>
  4. What are some historical examples of debt securitization?

    Find out how debt securitization started, how it works and why the government facilitated the mortgage-backed security market ... Read Answer >>
  5. Are all mortgage backed securities (MBS) also collateralized debt obligations (CDO)?

    Learn more about mortgage-backed securities, collateralized debt obligations and synthetic investments. Find out how these ... Read Answer >>
  6. If my mortgage lender goes bankrupt, do I still have to pay my mortgage?

    Yes, if your mortgage lender goes bankrupt you do still need to pay your mortgage obligation. Sorry to disappoint, but there ... Read Answer >>
Related Articles
  1. Investing

    What Happened To The MBS Market?

    Find out how the fall of mortgage-backed securities has changed the financial landscape.
  2. Investing

    What is Securitization?

    Securitization is the process of converting an asset, or group of assets, into a marketable security. Often times, the securitized assets are divided into different layers, or tranches, tailored ...
  3. Investing

    Profiting Off of Increased Mortgage Rates (PTRIX,FMSFX,VMBSX)

    Learn why mutual funds that invest in mortgage-backed securities (MBS) are worth a look for investors wanting to capitalize on rising mortgage interest rates.
  4. Investing

    Top 3 Mortgage Backed Securities (MBS) ETFs (MBB, MBG)

    Discover some of the best opportunities for investors seeking exposure to mortgage-backed securities through utilizing exchange-traded funds.
  5. Personal Finance

    Why Are Mortgage Rates Increasing?

    Learn how the secondary mortgage market and investor demand affect the cost of home ownership.
  6. Personal Finance

    Profit From Mortgage Debt With MBS

    Mortgage-backed securities can offer monthly income, a fixed interest rate and even government backing.
  7. Investing

    Find Security In Covered Bonds

    Find out about a safe investing alternative that could have prevented the subprime meltdown.
  8. Small Business

    The Rise And Demise Of New Century Financial

    A case study in how poor planning toppled a subprime mortgage giant.
  9. Personal Finance

    Shopping for a mortgage in 2016? Use this tool first.

    As home-buying technology has progressed, the process of finding the best mortgage rates for 2016 can all be done online.
  10. Personal Finance

    Shopping for a mortgage in 2016? Use this tool first.

    As home-buying technology has progressed, the process of finding the best mortgages rates for 2016 can all be done online.
RELATED TERMS
  1. Aggregator

    A party involved within the secondary mortgage market that purchases ...
  2. Guarantee Fees

    Fees charged by mortgage-backed securities (MBS) providers, such ...
  3. Weighted Average Coupon - WAC

    The weighted-average gross interest rates of the pool of mortgages ...
  4. Current Face

    The current par value of a mortgage-backed security (MBS). Current ...
  5. Mortgage Excess Servicing

    The percentage of the monthly cash flow that remains after the ...
  6. Secondary Mortgage Market

    The market where mortgage loans and servicing rights are bought ...
Hot Definitions
  1. Applicable Federal Rate - AFR

    Rates published monthly by the IRS for federal income tax purposes. These rates are used to calculate assigned interest charges. ...
  2. Foreign Exchange Reserves

    Foreign exchange reserves are reserve assets held by a central bank in foreign currencies, used to back liabilities on their ...
  3. North American Free Trade Agreement - NAFTA

    A regulation implemented on Jan. 1, 1994, that decreased and eventually eliminated tariffs to encourage economic activity ...
  4. Trickle-Down Theory

    An economic idea which states that decreasing marginal and capital gains tax rates - especially for corporations, investors ...
  5. Derivative

    A security with a price that is dependent upon or derived from one or more underlying assets.
  6. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
Trading Center