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Booyah Breakdown: MBS 101

Well, what if he doesn't? What if he was a subprime borrower, turned deadbeat?

The individual or fund who bought the security won't get its payment stream.

So what does that investor do?

Well, on one hand, that risk is part of the game. On the other hand, he could go back to Local Bank and request that it cover the loan.

Now the bank does have some money set aside for defective loans that it could give to the investors. But the defaults are coming faster these days, and that reserve has run out.

So now the bank's losses begin to mount, its stock price falls, and its profits are gone. "In addition, the bank now has no access to cash to fund new loans and sell them, so their business model no longer performs," says Keith Gumbinger, vice president of HSH Associates of Pompton Plains, N.J., which tracks a variety of loan products.

So now both the banks and the MBS investors are suffering.

But the banks get hit from both ends when they're in the subprime world. That's because many times the banks that offer subprime loans aren't able to sell those loans, notes Mark Grinis, a partner in Ernst & Young's real estate, hospitality and construction group.

So our Local Bank bears all the risk of those loans. And these days, that's not such a good thing.

OK. So that's a very simple run-through of the mortgage-backed security world.

Whew!

I'm sure you'd much rather go back to talking about Anna Nicole right about now.
Tracy Byrnes is an award-winning writer specializing in tax and accounting issues. As a freelancer, she has written columns for wsj.com and the New York Post and her work has appeared in SmartMoney and on CBS MarketWatch. Prior to freelancing, she spent four years as a senior writer for TheStreet.com. Before that, she was an accountant with Ernst & Young. She has a B.A. in English and economics from Lehigh University and an M.B.A. in accounting from Rutgers University. Byrnes appreciates your feedback; click here to send her an email.
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