Briefly illustrate the creation process of MBS

The creation of MBS involves several steps:

1. Origination: Mortgage loans are originated by banks, lenders or mortgage brokers. They assess the creditworthiness of borrowers, underwrite the loans and set the interest rates.

2. Pooling: The mortgage loans are pooled together by a financial institution, such as a bank or a government-sponsored enterprise (GSE), like Fannie Mae or Freddie Mac.

3. Securitization: The pooled mortgage loans are then sold to an investment bank or a special-purpose vehicle (SPV), which issues mortgage-backed securities (MBS). The SPV is typically a trust that holds the mortgage loans and issues the securities.

4. Tranching: The MBS are divided into tranches or classes based on their risk profile and cash flow characteristics. The most senior tranches are the safest and have priority in receiving interest and principal payments. The lower tranches are riskier and offer higher yields to compensate for the higher risk.

5. Credit enhancement: To make the MBS more attractive to investors, credit enhancement techniques may be used, such as over-collateralization, where more mortgage loans are included in the pool than required to cover the MBS, or subordination, where the senior tranches have a priority claim on the cash flows.

6. Distribution: The MBS are sold to investors, such as pension funds, insurance companies, hedge funds, and individual investors, through public offerings or private placements.

7. Servicing: The mortgage loans in the pool are serviced by a servicer, who collects the monthly payments from borrowers, manages delinquencies and foreclosures, and distributes the cash flows to the MBS holders.

8. Trading: MBS are traded on secondary markets, such as the bond market, where their prices fluctuate based on interest rates, prepayment speeds, credit quality, and other factors