Categorized | Housing Bubble

Mortgage Backed Securities For Dummies

The concept of a mortgage backed security (MBS) is essentially a financial derivative of a pool of mortgages. Here is a short video explaining the concept of a mortgage backed security.

As the video clip explains an MBS is a multiple-packaged mortgage loans to make another security. This process is known as securitization. These mortgage-backed securities are mainly sold by banks to reduce risk and increase liquidity. This newfound liquidity is used by banks to make further loans in the market.

What are the consequences of this securitization?

Since banks sell these MBS securities into the derivates market, it raises liquidity for the banks, thus able to offer loans and mortgages at lower rates, in order to be competitive. Mortgage lending is a highly competitive market.

People who could not afford a house or condominium now can afford one thanks to the lower interest rates. Although, in order to offset the extra risk of lower rates, government agencies like the Fredie Mae, Fredie Mac, (CMHC in Canada) have stepped in to guarantee these mortgage to the banks. In turn, this leads to an increase in demand for housing by buyers both qualified and unqualified.

The pretense of this bubble is that it will continue to increase until further debt cannot be piled on any further and one thing is for certain is that these are mostly malinvestments, created by the short-sightedness of investors who will realize the true nature of their investments only when interest rates rise to normal levels or when the bubble pops.

Subprime Time in Canada?

The problem is that the CMHC (a Canadian crown corporation) now accounts for approximately 90% of all mortgages in Canada and is used to insure banks in the event of a mortgage default. In exchange for this added risk from a low down deposit, individuals must pay an insurance premium to the CMHC. In turn, the crown corporation protects the bank in the event of a mortgage default. As such, these mortgages seem like bullet-proof investments–since, after all, the Canadian government is essentially guaranteeing them. These are then packaged into a security (MBS) and sold to other national and international banks.

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