Before the securitization process, a bank would issue a loan to a borrower. The same issuing bank collects the loan payments for the life of the loan. The same bank also services the loan with the borrower until the borrower fully pays off the loan. This process limited the banks ability to issue new loans without new capital or borrower deposits. Hence, Fannie Mae and Freddie Mac.

If the borrower defaults then the full losses from a defaulting loan is borne by the issuing bank. If too many of the banks loans go into default, the bank’s financial status may be jeopardized resulting in a shutdown by federal and state regulators or forced acquisition by larger banks.

In the 40s post depression era, in order to increase home ownership, the US Government formed Fannie Mae to recapitalize banks after issuing mortgage loans, by purchasing those mortgage loans from the banks. For the banks to be recapitalized, the government and regulatory authorities instituted strict lending guidelines for loans, and banks to qualify borrowers to prevent abuse and mass defaults.

Loan securitization otherwise afforded banks the opportunity to completely remove all risks of default arising from issuing loans to borrowers. Securitization process begins with the borrower and an originating lender, the Originator.

1. Loan Issued to Borrower [ie: $100,000 mortgage]
   1. The Loan Originator issues a loan to the borrower based on a loan application by the borrower, and approved by the lender, under certain criteria and lending guidelines that the Originator makes sure are met, in order to be sold on the secondary markets.
2. Loan Sold to investors in secondary markets multiple times
   1. Immediately after the borrower signs the loan and mortgage documents, the Originator sells the loan to the originator’s parent company or to multiple companies on the secondary markets who each time sell the loan for more than what was originally lent to the borrower.
   2. [ie: $100,000 loan sold for 110% of original loan amount to borrower or more].
   3. Investors / parent companies purchase the loan for more than what was originally leant to borrower because of the future revenue stream from the 30yrs of interest payments. If you look at your good faith estimates and amortization schedules in the documents you signed you will see the original amount borrowed and then the total cost of borrowing over 30 years. The result is staggering.
      1. If you borrow $350,000 at 5% interest over 30 years you will end up paying over $676,000. It is this profit in excess of the original amount borrowed is what investors are looking for, long term steady stream of interest revenue.
3. Consolidation of Loans with other loans into bankruptcy remote entities such as trusts, special purpose entities, special purpose vehicles.
   1. Through the secondary markets there are subsequent conveyances of the loans from one company to another, eventually the loans are consolidated into bankruptcy remote entities, usually in the form of a Trust or Special Purpose Entity.
   2. A consolidation company consolidates the loans with 1000 to 10,000 or more other loans amounting to billions of dollars of mortgages from borrowers with varying levels of credit worthiness (ie: credit scores from 500 – 800, documented, undocumented loans, etc).
4. Certificates or shares of these Special Purpose Entities are sold to Investment Bankers similar to a company’s initial public offering on the stock exchange.
   1. Investment Bankers purchase the certificates in bulk purchasing tens of millions to hundreds of millions of dollars of certificates for resale on the open markets like stock certificates.
   2. These certificates are then sold to institutional investors, insurance companies, mutual funds, municipalities, and other investments banks.