Economic Crisis: Did Mortage-Backed Securities Cause the Financial Crisis? Paul Krugman (2008)

A mortgage-backed security (MBS) is a type of asset-backed security that is secured by a mortgage, or more commonly a collection ("pool") of sometimes hundreds of mortgages. The mortgages are sold to a financial institution (a government agency or investment bank) that "securitizes", or packages, the loans together into a security that can be sold to investors. The mortgages of a MBS may be residential or commercial; 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 be more complex, made up of a pool of other MBSs. Other types of MBS include collateralized mortgage obligations (CMOs, often structured as real estate mortgage investment conduits) and collateralized debt obligations (CDOs).[1]





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 different level of priority in the debt repayment stream, giving them different levels of risk and reward. Tranches—especially the lower-priority, higher-interest tranches—of a 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 2006--8.

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

Low-quality mortgage-backed securities backed by subprime mortgages played a major role in the 2007--12 global financial crisis. By 2012 the market for high-quality mortgage-backed securities had recovered and was a profit center for US banks.

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.[40] In addition, off--balance sheet treatment for securitizations coupled with guarantees from the issuer are said to make the securitizing firm's leverage less transparent, thereby facilitating risky capital structures and allowing credit risk underpricing. Off--balance sheet securitizations are believed to have played a large role in the high leverage ratio of US financial institutions before the financial crisis.

One critical component of the securitization system in the US market is the Mortgage Electronic Registration Systems (MERS) created in 1990s, which created a private system wherein underlying mortgages were assigned and reassigned outside of the traditional county-level recording process. The legitimacy and overall accuracy of this alternative recording system have faced serious challenges with the onset of the mortgage crisis: as the US courts flood 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. 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 reflect dysfunctionality in the entire US mortgage securitization industry.

http://en.wikipedia.org/wiki/Mortgage...

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