This is my understanding of the mortgage backed security.Banks will give loans to customers, and then they decide to sell the loans to investment banks and charge a fee with it to earn profit. Now the investment banks will be earning the principal amount as well as the interest. But since, investment banks are not in the business of servicing loans or keeping loans on balance sheet, they create a special purpose entity. All mortgage payments will now go to this entity.
Now since, its a new entity and will be earning good amount of money through interest every year, investors will be willing to invest in this new entity. Investment bank also knows this and hence they issue shares
This is what happened during the financial crisis according to what I understood. But here is the question If the sub prime lenders and prime lenders default, how is it going to impact the share price. Also, let's say the share prices go down because people default and they aren't able to pay the interest rate then how is it going to impact the investment banks. Investment banks have already earned the money by selling the shares My third question is, why are these shares being called mortgage backed securities? The home owners are not buying these shares, it is the investors who are buying the shares. So let's say tomorrow company decides to sell the shares, how is that going to impact the home owner?