The money and capital markets are constantly adapting to meet new requirements and conditions. This has given rise to new types of securities that were not previously available.

Securitization refers to the transformation of illiquid, risky individual loans into more liquid, less risky securities referred to as asset-backed securities (ABS). The best example of this process, the mortgage-backed securities issued by the federal agencies mentioned above, such as Ginnie Mae, are securities representing an investment in an underlying pool of mortgages.

The federal agencies discussed earlier purchase mortgages from banks and thrift institutions, repackage them in the form of securities, and sell them to investors as mortgage pools. Investors in mortgage-backed securities are, in face, purchasing a piece of a mortgage pool, taking into consideration such factors as maturity and the spread between the yield on the mortgage security and the yield on 10-year Treasuries (considered a benchmark in this market). Investors in mortgage-backed securities assume little default risk because most mortgages are guaranteed by one of the government agencies. However, these securities present investors with uncertainty because they can receive varying amounts of monthly payments depending on how quickly homeowners pay off their mortgages. Although the stated maturity can be as long as 40 years, the average life of these securities to date has been much shorter.

Ginnie Mae issues are well known to investors. This wholly owned government agency issues fully backed securities (i.e., they are full faith and credit obligations of the U.S. government) in support of the mortgage market. The GNMA pass-through securities have attracted considerable attention in recent years because the principal and interest payments on the underlying mortgages used to collateralize them are "passed through" to the bondholder monthly as the mortgages are repaid.

As a result of the trend to securitization, other asset-backed securities have proliferated as financial institutions have rushed to securitize various types of loans.

Marketable securities have been backed by car loans, credit-card receivables, railcar leases, small-business loans, photocopier leases, aircraft leases, and so forth. The assets that can be securitized seem to be limited only by the imagination of the packagers, as evidenced by the fact that by 1996 new asset types include royalty streams from films, student loans, mutual fund fees, tax liens, monthly electric utility bills, and delinquent child support payments.

Who do investors like these asset-backed securities? The attractions are relatively high yields and relatively short maturities (often, five years) combined with investment-grade credit ratings, typically the highest two ratings available. Investors are often protected by a bond insurer. Institutional investors such as pension funds and life insurance companies have become increasingly attracted to ABS because of the higher yields, and foreign investors are now buying these securities more often.