Mortgage-Backed Securities: Understanding Their Structure and Risks

This lecture provides an in-depth analysis of the US mortgage-backed securities (MBS) market, focusing on both agency and non-agency MBS. It begins with an overview of the historical context and the role of government-sponsored enterprises like Fannie Mae and Freddie Mac in guaranteeing credit risk. The instructor discusses the significant growth of MBS since the 1970s, highlighting that about two-thirds of residential mortgages are now securitized. The lecture explains the different types of MBS, including pass-through securities and collateralized mortgage obligations (CMOs), detailing how cash flows are structured to appeal to various investor segments. The risks associated with agency MBS, primarily interest rate risk, and the additional credit risks in non-agency MBS are thoroughly examined. The lecture also touches on the concept of credit enhancement and the importance of structuring in reallocating risk. Finally, the instructor contrasts the MBS market with the covered bond system in Switzerland, providing insights into why MBS have not gained traction in that country.