Life is constantly providing us with new funds, new resources, even when we are reduced to immobility. In life’s ledger there is no such thing as frozen assets.

—Henry Miller

Many asset types are securitized: corporate bonds, credit card debt, auto loans, student loans, residential and commercial mortgages, and so on. The purpose of this chapter is to introduce residential mortgages. Although mortgages are in general more complex than the “average” securitized asset, they still demonstrate how assets are placed into a securitization and how the asset characteristics affect the structure. Once the reader has learned about residential mortgages, it is a relatively small step in complexity to analyze other asset-backed securities (ABSs).

Consider credit card debt, for example. Credit card securitization operates on the same principles as mortgage securitization in that excess spread and over-collateralization give the credit enhancement needed to protect the structure. Debt holders have the option to prepay their loans, just as in mortgages. Like mortgages, credit cards usually charge floating rates. The trust into which the debt is placed may have caps or swaps to protect it against basis risk. Unlike a generic mortgage, credit card debt revolves; that is, it can grow and shrink. There are mortgages that exhibit similar behavior, for example, a home-equity line of credit (“second mortgage”) and an option ARM (an adjustable-rate mortgage that can grow in balance). ...

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