Learning the Language

Asset Backed Security is a financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed securities.

Mortgage-Backed Security is a security that is backed by a mortgage or collection of mortgages. These securities must also be grouped in one of the top two ratings as determined by an accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments.

When you invest in a mortgage-backed security you are essentially lending money to a home buyer or business. An MBS is a way for a smaller regional bank to lend mortgages to customers without having the assets to cover the loan. Instead, the bank acts as a middleman between the home buyer and the investment markets.

Excerpted from Bob Prechter:
“This type of security is also commonly used to redirect the interest and principal payments from the pool of mortgages to shareholders. These payments can be further broken down into different classes of securities, depending on the riskiness of different mortgages as they are classified under the MBS.

One of the ways that a lot of this real estate debt was financed is very unusual historically, and that is through asset-backed securities. They really came into their own in the decade of the 2000s up until 2007. A lot of people feel that such investment was normal, but it wasn’t. For years and years, housing was built essentially to provide a home for people; in other words, it was a consumption item. But in the 2000s it turned into an investment item for people other than bankers. Wall Street packaged mortgage loans and began selling them as investments to people who didn’t look very hard at what they were buying. And they didn’t feel that they had to because, again, they felt that they were covered, at least with Fannie and Freddie mortgages, by implied guarantees from the federal government.

What’s happened, though, is that the issuance of asset-backed securities has fallen nearly to zero, not far from where it started. This method of financing is abnormal and something that comes along maybe once a century, when financiers get together and figure out a way to dress up and distribute IOUs in a certain investment area. So it is very unlikely that we will be returning to this type of financing anytime soon.”