Well a security (a financial security which this term implies) is a financial asset that can be bought and sold on an open market (much like stocks. which are financial securities). Mortgage debts are a little more difficult to explain but I'll try to make it short and sweet.
1) People buy houses, and take out mortgages from banks in order to pay for them. it's a secure loan which means that the bank has an interest in the house. If the person who takes out the mortgage fails to pay, the bank will repossess the house and sell it, taking the remainder of the amount they're owed.
2) Banks don't actually own the mortgages anymore. they are too long-term (they take decades to earn a profit on), so the banks can actually sell the mortgage debt to someone else, who buys it for a one-time price, and owns the debt. In simple terms, I can buy the mortgage debt from the bank, so you mortgage payments aren't actually going to the bank. they're going to me. Since I don't mind waiting the many years until I make a profit, I don't mind holding on to it (the bank wants to have money quicker, which is why they sold it.)
3) I don't actually buy the mortgage debt from the bank, the bank sells it to a secondary mortgage market (Fannie Mae and Freddie Mac are examples of these). These large companies were created for good reason, to take the risk associated with mortgage debt off the bank's hands, which encourages banks to give out more mortgages to the public. Fannie Mae and Freddie Mac, among others, are collectively known as the secondary mortgage market. They make money because they then package together many of these mortgages that they bought from banks into large "bundles," which they then turnaround and sell to investors (individuals like you and me, or most often large investment firms that make money off of buying a lot of these packages). The money they make is from commissions (like a clearinghouse. they charge commission from both the banks and the investors who buy them for their efforts in providing services for
this secondary mortgage market).
4) So what has happened? Mortgage debt has been packaged up and turned into a financial security which can be bought and sold on a financial market, which is what securitization means.
All this is all well and good. afterall it lets the lower-middle class buy homes because banks are more willing to approve mortgages. but this is exactly how the financial crisis started.
That's another story but here's the gist.
1) As you know, the real estate market was booming and all property values were going up unsustainable (this creates a "bubble" on a chart, which can be popped and send everything spiraling down. which happened).
2) Banks were so eager to give out as many mortgages as they could, because they could turnaround and sell them to Fannie Mae or Freddie Mac for a sure, quick profit. The risk was overlooked by the banks, and passed on to the secondary mortgage market, where it sort of "got lost" in the bundles of other securities that were packaged together. Banks were giving out mortgages to people who didn't even put money down. (subprime mortgages), which is extremely risky.
3) All this risk accumulated. and when the real estate bubble burst, middle class people who had saved up all their money to buy these houses at a very high cost, now were stuck with massive mortgage payments for houses that were worth much less now. This is a recipe for foreclosures, on a massive scale. The banks went in and repossessed all these houses. and the mortgages began being worth nothing.
4) The mortgage collapses quickly reached the secondary market, where investors were no longer purchasing bad mortgage debt bundles, because they were no longer worth anything. Fannie Mae and Freddie Mac were left out to dry, and they folded like a stack of cards under a mountain of risk.
And there you have it. the government stepping in to bail out the secondary mortgage market. without the bailout, the system would have collapsed. We can only hope it wasn't just a postponement of something worse to come.
Jack M · 5 years ago