A mortgage-backed security, or MBS, is any security whose underlying value is based on one or more property mortgage loans.

The mortgage-backed security, almost always in the general structure of a bond, is a synthetic financial product that aims to to repackage real estate loans made by banks into something that can be traded more readily. As such, most MBS have an interest or dividend payment structure and are traded in over-the-counter (OTC) markets or on exchanges.

The Mortgage-Backed Security in Theory

Mortgage-backed securities were developed as a means for interested parties to invest in the housing market without needing to issue mortgage loans directly and for banks to take the profit from structuring mortgage loans without having to keep the loans on their books for decades.

The Mortgage-Backed Security and the Financial Crisis

In practice the creation of MBS was so lucrative that riskier and riskier mortgages were being issued, with the resulting MBS being sold on to yield-hungry investors who did not have the ability to properly price these mathematically complex financial instruments.

The increased demand for mortgages to put into MBS eventually drove the real estate markets of a number of nations into a worldwide bubble, which burst catastrophically and led to a half-decade of global economic stagnation.

Final Thoughts

There is nothing inherently wrong or dangerous about mortgage-backed securities.

Allowing investors to take a position in the real estate market without needing to directly own property and allowing banks to divest themselves of mortgage loans are both generally positive for modern economies. However, the confluence of greed and ignorance that led to the financial crisis has made mortgage-backed securities an unwelcome term in the public sphere and most financial circles.

Many mortgage-backed securities now exist again, and it will be a struggle between their inherent value and their associated stigma to determine the future of MBS in the investing world.