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. Are mortgage-backed securities backed by any guarantees?

    Actually, any mortgage-backed security (MBS) guarantee depends on who issued it.To review, an MBS is a security, created ... Read Answer >>
  2. Why do MBS (mortgage-backed securities) still exist if they created so much trouble ...

    Read several different arguments in favor of allowing the trade of mortgage-backed securities, even after the financial crisis ... Read Answer >>
  3. 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 >>
  4. 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 >>
  5. 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. Personal Finance

    Behind the Scenes of Your Mortgage

    Four major players slice and dice your mortgage in the secondary market.
  4. Investing

    The ABCs of Mortgage-Backed Securities ETFs

    ETFs focused on mortgage-backed securities, or MBS, offer an opportunity to further diversify the fixed-income portion of your portfolio.
  5. 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.
  6. 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.
  7. Investing

    Top Mortgage-Backed Securities ETFs

    Investing in mortgage-backed securities has many advantages, but studying their history may make you wary.
  8. Investing

    Investing In Securitized Products

    Securitized assets are customizable and have a wide range of yields, making them an attractive asset class.
  9. Personal Finance

    Why Are Mortgage Rates Increasing?

    Learn how the secondary mortgage market and investor demand affect the cost of home ownership.
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. Mortgage-Backed Security (MBS)

    A type of asset-backed security that is secured by a mortgage ...
  4. Weighted Average Coupon - WAC

    The weighted-average gross interest rates of the pool of mortgages ...
  5. Secondary Mortgage Market

    The market where mortgage loans and servicing rights are bought ...
  6. Primary Mortgage Market

    The market where borrowers and mortgage originators come together ...
Hot Definitions
  1. Leverage

    1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. ...
  2. Trumponomics

    Trumponomics is a term for the economic policies of President Donald Trump.
  3. Universal Health Care Coverage

    An organized healthcare system that provides healthcare benefits to all persons in a specified region. Many countries, such ...
  4. Davos World Economic Forum

    The annual meeting of the World Economic Forum hosted at Davos—a small ski town in Switzerland—in January each year is among ...
  5. Smart Home

    A convenient home setup where appliances and devices can be automatically controlled remotely from anywhere in the world ...
  6. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
Trading Center