Mortgage backed Securities

After more than a year in hibernation, I am going to start blogging again. Hope this time , I will be more prolific than my previous attempts. From here on, most of my posts are going to about investment banking or financial products related. Just thought that I should jot down whatever limited knowledge I have acquired in the last five years. So here's the first installment.
I am going to talk briefly about Mortgage backed Securities , just a general overview. In the next few weeks we will get into more details.

What are Mortgage Backed Securities?
MBS is very much similar to bonds, but here the securities are backed by mortgages. A bond is a promissory note where a corporation (or a Government) obliges to pay a certain sum of money every month and at the end of term repay the original sum back. In the case of MBS, the repayment is backed by mortgage payments (by the homeowner).

On a broader level, this is what happens. A few mortgages which are similar in nature are pooled together. They are securitized by either a Quasi governmental agency (FNMA, GNMA etc) or a corporation. These pools of MBS are sold to other institutions. Every month, the owner of the pool will receive a portion of the interest payment and principal on the mortgages. There are many risks associated with the cash flow, right from prepayment to loan defaults. Because of MBS the risk of the loan is distributed among all the stakeholders and is not limited to only the small bank which lent the money ( not sure whether it’s a good thing or a bad thing :-) )
Other than small banks looking for liquidity, MBS is a good way of converting a illiquid asset into a tradable instrument. It allows the banks or the originators to diversify the financing sources as an alternative to traditional bonds and stocks. Balance sheets looks more sleek, and the risk is now distributed across the globe.