The high foreclosure rate and declining housing market have contributed to the mortgage-backed securities crisis. Photo CL

In October 2008, U.S. President George W. Bush signed into law a bill for a $700 billion financial rescue plan to stabilize the economy. Among the items the government would be purchasing were “toxic” securities that were festering in the global market.

As part of the bank rescue plan, President Bush requested bids from managers of mortgage-backed securities. With this historic government intervention, the topic of mortgage-backed securities has been mentioned on many occasions.

They have been a drain on the economy and contributed to this financial crisis, contributing to the insolvency of many banks and investment firms that have been around for decades. But many people aren’t quite sure just what mortgage-backed securities are.

The mortgage-backed securities (MBS) market came into play in the early 1980s. Before then each mortgage was a separate transaction from a bank. With MBSs, companies such as the now defunct Bear Stearns or Lehman Brothers buy several mortgages from a primary lender, which is the company from which you actually received your mortgage.

This “pool” of mortgages is used by investment banks that use your monthly payments, and those of thousands of others whose mortgages have been bought out, as the revenue stream to pay investors who have bought chunks of the securities offering.

This scenario allows smaller lenders to replenish funds and continue to sell mortgages to the people who want them. (CL)