Definition: Mortgage-backed securities are a bundle of mortgages that have been sold by banks to Fannie Mae, who then repackages them and sells them to individual investors. This allows the banks and mortgage companies to sell mortgages off, and take them off their balance sheets. This removes one constraint on banks to make sure the loans are to qualified borrowers.
During the real estate boom, many less careful banks and mortgage companies made loans with no money down, thus allowing people to get into mortgages they really couldn't afford. The lenders didn't care as much, because they knew they could sell the loans, and not pay the consequences when and if the borrowers defaulted.
The ability to create mortgage-backed securities was authorized by the 1968 Charter Act which created Fannie Mae. The intent was to allow banks to sell off mortgages, thus freeing up funds to lend to more homeowners. The founders didn't anticipate that this would also remove an important discipline for good lending practices
Examples:
Fannie Mae packages mortgages into mortgage-backed securities, which they then resell to investors.
