Mortgage-backed securities

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Mortgage-backed securities are bonds financed by mortgage payments on home loans generated across the country, and usually issued by large goverment-regulated mortgage-repurchasing agencies like Fannie Mae (FNMA), Ginnie Mae (GNMA) and Freddie Mac (FHLMC).[1]

These securities had until recently grown in popularity because they typically provided higher yields than traditional fixed-income securities like treasury bonds because of default and pre-payment risks. The market collapsed in 2007 after defaults on subprime mortgages soared and the securities' underwriters like now-defunct Bear Stearns were forced into huge writedowns.[2]

Over-rated

A key factor in these losses were the high ratings awarded mortgage-backed securities by credit-rating agencies like Moody's and Standard & Poor's despite their shaky foundations. Moody's executives have admitted that computer glitches were partly responsible for some incorrect ratings but also blamed issuers for poor information.[3] Subprime mortgages represented about a fifth of the total U.S. mortgage market of $3 trillion in 2007.[4]

Long and short

Despite - or perhaps because of - the market turmoil, BGI iShares in March 2008 launched its iShares Lehman MBS Bond (symbol: MBB),[5] an ETF that tracks the value of outstanding investment grade U.S. mortgage-backed securities in the Lehman Brothers U.S. MBS Fixed-Rate Index. Traders and investors can short the MBB as well as go long, gaining exposure to fixed-income securities and official interest-rates.[6] The fund at inception had $20 million in assets invested in (presumed) triple-A securities issued by Fannie Mae (51%), Freddie Mac (39%) and Ginnie Mae (10%).

References

  1. Mortgage-Backed Securities. Fidelity Investments. Retrieved on June 23, 2008.
  2. The financial instrument that destroyed Bear Stearns. Slate.com. Retrieved on June 23, 2008.
  3. Moody's Official Concedes Failures in Some Ratings. New York Times. Retrieved on June 23, 2008.
  4. World markets engulfed by US mortgage crisis. The Guardian. Retrieved on June 23, 2008.
  5. iShares Lehman MBS Bond (MBB). Yahoo Finance. Retrieved on June 23, 2008.
  6. Home on the Exchange. Motley Fool. Retrieved on June 23, 2008.
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