President

Box 2-4: Securitization and Structured FinanceSecuritization is the transformation of a collection of individual assetsinto tradable securities. These “asset-backed securities” are createdby financial institutions—including banks and government-sponsoredenterprises—from pools of assets, such as mortgages, car loans, creditcard loans, corporate receivables, and student loans.Mortgages make up a large fraction of asset-backed securities.Traditionally, a lender makes a loan to a borrower, in what is called theprimary market. In the secondary market, a financial institution buysmultiple loans, which, taken together, are essentially a bundle of cashflows. The simplest mortgage-backed security is a pass-through security,for which the interest and principal payments of the individual loanspass through to the holders of the new securities.Securitization has two major economic benefits: increased riskdiversification and increased available capital. With securitization, aninvestor with $400,000 can own 1 percent portions of 100 $400,000 mortgagesrather than having to purchase a single such mortgage. If a singlecontinued on the next page60 | Economic Report of the President