Not too long ago, banks held most of their mortgages to maturity, and homeowners knew exactly who held their mortgage from the moment it was originated until the time it was paid off. These days, however, many mortgages are packaged into securities and sold to investors. This securitisation has both advantages and disadvantages, and it is important to consider the pros and the cons.
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Fixed-income investors are always looking for higher yields, and mortgage-backed securities can provide higher yields than those available from certificates of deposit, savings accounts and Treasury bonds. Securitising mortgages provides those fixed-income investors with an interesting opportunity and a way to benefit from changes in interest rates.
Increased Risk Taking
On the down side, securitising mortgages introduces some institutional risk. When banks hold the mortgages they write, there is a good chance those banks will be very careful about to whom they loan money, because if those mortgages go bad, the banks are responsible for them. But when mortgages are securitised and sold, the risk inherent in those mortgages is shifted to the buyers of the mortgage-backed securities. This can entice some banks to take more risks than they should, since they no longer have to suffer the default if the mortgage goes bad.
Potential for Fraud
Packaging dozens or even hundreds of mortgages into a mortgage-backed security can come with the potential for fraud. The end buyers of these securities might have trouble working out exactly what they own, and if the mortgages used to build the security are not quality instruments, the security itself could be next to worthless. In addition, the value of mortgage-backed securities could vary wildly along with the quality of the mortgages held.
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