---
title: "Mortgage-Backed Securities | Principles of Economics"
description: "Mortgage-backed securities are tradable pools of mortgages that turn home loans into investment products, a major force in deregulation, credit expansion, and crisis risk."
canonical: "https://fiveable.me/principles-econ/key-terms/mortgage-backed-securities"
type: "key-term"
subject: "Principles of Economics"
unit: "Unit 11"
---

# Mortgage-Backed Securities | Principles of Economics

## Definition

Mortgage-backed securities are investments made from pools of mortgage loans, so investors receive the cash flows from homeowners’ payments. In Principles of Economics, they show how securitization can expand credit and spread financial risk.

## What It Is

Mortgage-backed securities, or MBS, are financial products created when lenders bundle many mortgage loans together and sell claims on the payments from those loans. In Principles of Economics, they are a clear example of securitization, which turns loans that are hard to trade one by one into assets that can move through financial markets.

Here is the basic mechanism. A bank or mortgage originator makes home loans, then packages those mortgages into a pool. Investors who buy the MBS receive money from the monthly mortgage payments, minus fees and servicing costs. Instead of one lender waiting decades for one borrower to repay a single loan, the cash flow is split across many mortgages and many investors.

This matters because MBS change how credit markets work. When lenders can quickly sell mortgages into securities, they get cash back and can make more loans. That can increase home buying and expand access to credit, especially when demand is strong and lenders want to keep originating new mortgages.

The catch is that MBS can hide risk if the underlying loans are weak. A pool built from risky subprime mortgages may look safe at first because the loans are spread out, but if many borrowers default at the same time, the security loses value fast. That is one reason mortgage-backed securities became central to the 2007 to 2008 financial crisis.

In the deregulated financial environment described in Topic 11.4, MBS grew because financial firms had more freedom to create and trade complex instruments. Government-sponsored enterprises like Fannie Mae and Freddie Mac also helped by buying and securitizing mortgages, which supported liquidity in housing finance. So MBS are not just a “thing you can buy,” they are a mechanism that links households, banks, investors, and the broader economy.

## Why It Matters

Mortgage-backed securities are a clean way to see how financial innovation can expand markets and also spread danger through the system. In Principles of Economics, they connect housing demand, credit supply, investor behavior, and regulation in one example.

If you are tracing the Great Deregulation Experiment, MBS show the upside that supporters promised: more lending, more liquidity, and more competition in finance. Lenders were not stuck holding every mortgage forever, so they could move money back into the market and issue new loans.

They also show the downside of complexity. When loans are bundled, sold, and repackaged, it becomes harder to see the quality of the underlying assets. That makes it easier for bad loans, especially subprime mortgages, to spread through the financial system.

This term is also useful for understanding why policymakers responded after the crisis with stricter oversight and more attention to transparency. In short, MBS help explain how one financial product can affect housing prices, bank balance sheets, investor risk, and the larger economy at the same time.

## Connections

### [Securitization](/principles-econ/key-terms/securitization)

Mortgage-backed securities are one of the best examples of securitization. Securitization is the process of turning loans or other debts into tradable securities, and MBS are what you get when the underlying assets are mortgages. If you understand securitization, you can explain why lenders can make more loans and why risk gets spread across investors instead of staying with one bank.

### Subprime Mortgage

Subprime mortgages are a major reason MBS became dangerous before the financial crisis. These loans were given to borrowers with weaker credit histories, so they were more likely to default. When lots of subprime loans were bundled into mortgage-backed securities, the whole pool became riskier than it looked on paper.

### [Great Recession](/principles-econ/key-terms/great-recession)

MBS are one of the financial products most closely tied to the Great Recession. As mortgage defaults rose, the value of these securities fell, which hurt banks, investors, and the credit system. If you are explaining the recession, MBS help show how problems in housing finance spread into the broader economy.

### [Moral Hazard](/principles-econ/key-terms/moral-hazard)

Moral hazard helps explain why mortgage-backed securities encouraged risky behavior. When originators could sell loans quickly instead of keeping them, they had less incentive to check whether borrowers could really repay. That separation between making the loan and holding the risk made the system more fragile.

## On the AP Exam

A quiz question might ask you to identify how mortgage-backed securities affected credit markets or why they mattered in the 2007 to 2008 crisis. A strong answer should trace the process: mortgages are pooled, securities are sold to investors, lenders get new cash, and the risk from home loans gets spread through the financial system.

If you see a short-response prompt about deregulation, use MBS as the concrete example that shows both sides of the policy change. You can explain that they increased lending and liquidity, but also made the housing market more vulnerable when risky loans piled up.

In a case study or discussion, look for the link between subprime lending, securitization, and default. The best responses do not just define the term, they show what happens when mortgage payments stop flowing and the security loses value.

## Mortgage-Backed Securities vs Collateralized Debt Obligation (CDO)

MBS and CDOs both bundle debt into tradable securities, so they are easy to mix up. The difference is that MBS are built from mortgage loans, while CDOs can be built from a wider mix of debts and often include tranches of other securities, including MBS. If a question is specifically about home loans, MBS is the better match.

## Key Takeaways

- Mortgage-backed securities are pools of mortgage loans sold as tradable investments that pay investors from homeowners’ monthly payments.
- In Principles of Economics, MBS are a major example of securitization and financial innovation in the deregulated financial system.
- They can expand lending because banks get cash back quickly and can issue more mortgages.
- They also increase systemic risk when the mortgages inside the pool are low quality or widely defaulting.
- MBS are strongly connected to the housing bubble, the Great Recession, and the push for tighter financial regulation afterward.

## FAQs

### What is mortgage-backed securities in Principles of Economics?

Mortgage-backed securities are financial assets made from pools of home loans. In Principles of Economics, they show how banks can bundle mortgages, sell them to investors, and free up cash for more lending.

### How do mortgage-backed securities make money?

They make money from the payments homeowners send on their mortgages, minus fees and servicing costs. Investors in the security receive a share of those cash flows, so the value of the MBS depends on whether borrowers keep paying.

### Why were mortgage-backed securities risky during the housing bubble?

They were risky because many pools contained subprime mortgages and other weak loans. When default rates rose, investors lost confidence, the securities fell in value, and the damage spread through banks and credit markets.

### Are mortgage-backed securities the same as collateralized debt obligations?

No. Both are securitized products, but MBS are specifically backed by mortgages. CDOs can be backed by a broader mix of debts and financial assets, so they are related but not the same.

## Related Study Guides

- [11.4 The Great Deregulation Experiment](/principles-econ/unit-11/4-great-deregulation-experiment/study-guide/47Dwd2rgkVvtcfMy)

## About This Document

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