Mortgage Backed Security (MBS)
From iGeek
An MBS is a diversified package of many loans, to lower the risk by not tying it to any one area/demographic.
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- An MBS (Mortgage Backed Security) is where a company (Fannie/Freddy) buys a bunch of loans, package them up in sort of a stock (security), and then sells them like they’re on the stock market.
- The idea is that if you're a local bank, and you make a bunch of loans in your area, you're not very diversified geographically. If the local market tanks, all your assets tank. That increase risk.
- The idea of an MBS is that you mix in lots of loans (from all over the nation) to geographically diversify the risk — you’re not buying in just one market (and riding the ups and downs), you’re doing it nationally. This creates a national market for real-estate, instead of problems with local supply and demand. And the whole nation’s real-estate market would have to tank at once, before your assets tanked (and that hadn't happened since the 1930's so was unlikely). So it reduced risk (and thus the cost of money — as the risk/reward ratio says).
- It also bundles different types of property (demographically diversified), instead of buying just McMansions and Middle Class homes with great credit ratings (prime), you also got some poorer homes, lower credit ratings and higher risk (sub-prime) . MBS’s (and Fannie/Freddy) were created to get investors to all take on this risk of poorer / higher risk loans as part of their portfolio. Otherwise, the costs of capital (interest rates) would be too high for many poor people to get into homes.
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Tags: Terms Financial Terms
