Mortgage-Backed Securities

Every time they talk about these mortgage-backed securities on NPR, reporters say that mortgages were “sliced and diced” and bundled up into these mortgage-backed securities that are now at the heart of the financial crisis. Furthermore, I keep hearing that the reason it is so hard to put a value on these securities is that it is “impossible” to open them up and see inside and find out what mortgages are inside and whether anyone is paying on them or not.

So–why is it impossible to do this? (Or, is it really impossible?)

This PDFtranscript of an NPR story puts it in pretty plain language.

I work at a law firm that did a lot of security filings for mortgage-backed security pools. This is what I gleaned from years of putting these filings together. It may not be 100% accurate (IANAL), but only in the details, not the facts.
Mortgage-backed securities are bonds issued against a “pool” of mortgages. The bonds are issued in “tranches” (which is French for “slice”). At the end of each collection period, the aggregate mortgage collections for the pool are distributed among the tranches, First Tranche getting paid first, and so on down the line. A tranche does not refer to any particular mortgages in the pool - just to the order of right of payment.

When mortgages in a pool begin to default, it is the higher numbered (or lettered) tranches that will suffer first. If all tranches are “up to date” any excess goes back to the First Tranche bonds. First Tranche bonds are always the first to mature because of this. If all First Tranche bonds are redeemed, then any excess would go to the second tranche bonds until they are paid in full. As you can see, risks will increase for the higher numbered tranches with the highest numbered tranches being the last paid off in full.


Holy crap.