Finance and capital markets
Mortgage-backed security overview
Basics of how a mortgage back security works. Created by Sal Khan.
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- Why would someone not want to be an end holder of the mortgage? Wouldn't they be the ones making the most money?(13 votes)
- Because people who hold the mortgages also hold the risk, while intermediaries can make a tidy profit just brokering the sale of securities to other investors (hedge funds, pensions, other banks, etc.)(37 votes)
- Why does it seam like that these videos are not in order of a proper university curriculum?(0 votes)
- This curriculum order was selected by a hedge-fund analyst and his sharp team. Your universities are likely far behind Khan Academy.(15 votes)
- So, are mortgage backed securities more like shares or bonds? If they are more like bonds, then is it correct to think of it as share holders indirectly lending money to home owners?
If they are more like shares, then could share holders actually take control from the investment bank? Also, how would the IPO work? I'm a little confused since the SPE is sort of a dummy company.(5 votes)
- The buyer of a MBS is buying a portion of the total amount the investment bank paid for the "ownership" of the loans and therefore receiving loan payments on interest which flow to the MBS shareholders in the form of a dividend.(2 votes)
- Since MBS is a security and has liquidity, it can be traded, which means its price fluctuates. I am trying to figure out how its price is related to the mortgage interest. My broker showed me a chart of FNMA 30yr, and told me that the underlying security shows opposite trend of the mortgage rate, i.e. the higher the price of the stock, the lower the interest rate, and vice versa. Can someone explain why this is the case?(2 votes)
- This is because the rate of the MBS is fixed, while the rate you were looking at (FNMA 30yr) is the actual market rate as of today. So, let's assume the FNMA 30 year rate is 5% and you want to buy a 30year MBS. You'll obviously expect (and get) 5% interest, which is the current market rate. Now, if tomorrow the FNMA 30yr rate goes up to say 6%, and you want to get rid of your 5% MBS you are not going to be able to sell it for the same price, because potential buyers could get a "fresh" MBS yielding 6%. Therefore, the price of the 5% MBS you bought yesterday will have gone down, while the market (FNMA 30yr) rate went up. The other way round, if the market rate had gone down to 4% you would be able to sell your 5% MBS at a higher price than you bought it, because the a potential buyer of a "fresh" RMBS would only get 4%, so they will be willing to pay you a premium for your 5% MBS to get the additional 1% interest.(6 votes)
- Why would an investor want to buy these MBS?(1 vote)
- I'm pretty sure it's because whoever holds the MBS collects the interest payment of all the homeowners whose mortgages make up that MBS. Which is why, when people started defaulting on their mortgages and foreclosing, everything went sour(6 votes)
- Thanks for the lesson. There's one thing I don't understand. I do understand from the comments that mbs are tradeable and their prices can vary, but if the mortgages have a fixed interest, you know exactly how much those are worth, I mean the people who actually took the loan are not going to give a penny more than what was agreed, the way I see it, the mbs prices could never go up, it would remain the same (best scenario) or down (people default on loans). What am I missing here? Why would I want to buy a mbs for a price higher than the price it started?(2 votes)
- Since the investment bank sold shares of SPE, which in essence, recovered the money used to buy the mortgages. When home owner defaults on the loan, isn't the stock holder who lost money and not the investment banks? Wonder how Mortgage backed security are to blame for the housing crisis.(2 votes)
- you dont seem to understand the housing crisis properly. housing crisis was basically a sharp decline in the price of houses which were earlier priced way higher. when borrowers defaulted on their loans the only option the authorities ( whoever was in possession of the mbs) had was foreclosure. foreclosure would often yield them less money than the lone, why? because bank didn't want to keep illiquid assets on their balance sheets so they wanted to sell them as early as possible even if it gave them a 50%return on the loan. with this increse in the supply and a following constant decrease in demand the prices went down. the houses which were financed for say $1M were now worth only $600k (say) leading to a great loss of wealth.(2 votes)
- Does an investment bank (IB) create one SPE, or one SPE per year, multiple SPEs per year?
Do these SPEs have the same CEO and administration as the IBs? It seems odd to me you'd create an SPE, and also increase salary expenses on a new CEO and administration if you're trying to maximize profits. I don't understand why the IB essentially can't do the same thing the SPE does; while, the IB wouldn't exactly sale shares, the IB could create some-kind of deal where the IB sales something like a contract to "contract-holders" instead of shareholders...Do these SPE's even need a building then, or would they use the address of the investment bank's headquarters?(1 vote)
- A bank can create as many SPE as it desires. The point of a SPE is to make it a completely separate entity. It is in no way legally tied to the original investment bank. There are many people involved in the securitization process (originators, underwriters, issuer/trust, servicer, independent accountants, attorney's, ratings agencies, guarantors). Some of these people may be people that work for the investment bank. But, the main point is that it is a separate legal entity. If something happens to the SPE, the shareholders or bondholders in the SPE cannot legally come after the bank that originated the SPE.(4 votes)
- What are asset backed securities ..?? Apart from Mortgage Backed Securities(MBS), what are the other examples of asset backed securities..?/(1 vote)
- To be slightly more specific, an ABS is any cash-flow that is secured by an asset. The ones that made the crash worse were secured by thinks like office buildings-- they were essentially syndicated loans where the issuing bank didn't hold any risk and ended up using statistically insignificant numbers of loans. To give a point of reference, a typical MBS will have 3,000 mortgages in it, whereas a typical ABS that is backed by commercial property (a mall or skyscraper, for example), would have 10-20 loans that are dramatically larger, so the MBS and ABS would both be worth ~$1bn, but the ABS would be 10 loans of $100m/ea, whereas the MBS would be 3,000 loans of ~$300k/ea.(2 votes)
- So what is a Special Purpose Entity?(1 vote)
- A special purpose entity is just a separate corporation that is created by a corporation (such as an investment bank) that serves to do a specific kind of business, for instance MBS. The advantage of this is that the SPE's gains, losses, and liabilities do not effect its parent corporation, thus reducing risk. :)(1 vote)
Let's say I'm some type of the Investment Bank. Can I go out there and I buy a whole bunch of mortgages. So right here are a whole bunch of people's mortgages. And when I say buy a mortgage it means the home-owners who borrow the money instead of the money going to the mortgage broker whom the home-owner think they got the loan from the servicer who they think they are paying the check to. Since I now have bought these mortgages, I've essentially become the lender to the home-owner, and so the home-owner's morgage payment will now come to me the Investment Bank . So I do this for a bunch of home-owners right over there. But I don't want to be the end holder of the paper. I really want to be the intermediary. So what I do is I set up a Special Purpose Entity, which is really just a corporation that I set up. And I stick all of the mortgages inside that Special Purpose Entity. So I stick them all inside of that. So now the Special Purpose Entity is the owner of the mortgages . The investment bank at least starting off with all of the shares of the Special Purpose Entity. And so the Investment Bank could then sell shares. It could split the Special Purpose Entity into a million or ten million shares and then sell those shares to investors. And these shares would be called Mortgage-Backed Securities. or sometimes MBSes. There are a part of a general class called Asset-Backed Securities because what is going to happen now is that all of this money flowing from home-owners will go the mortgages which is now on the Specail Purpose Entity. So all ended up inside the Special Purpose Entities . And some of them will default,some of them won't. But on average this Special Purpose Entity will then be able to pay a dividend. Essentially you can almost fueled on interest to the owner of the Mortgage-Backed Security.