Mortgage Pool

See: Mortgage.

You may have heard of a mortgage-backed security. They became famous during the financial crisis of 2007-2008. They were debt instruments (similar to bonds) that were backed by a group of home mortgages. Watch The Big Short if you haven't.

Wall Street banks bought tons of them during a housing boom of the early part of the 2000s, thinking they were safe investments. They were then stuck holding a bunch of them when the market collapsed, leading to a financial crisis and an eventual government bailout.

Mortgage pools provide the basis of mortgage-backed securities...like how batter provides the basis of a cake, or how water provides the basis of a wet t-shirt contest. A mortgage pool consists of a group of similar mortgages...borrowers with similar credit scores buying houses of similar values. These get bundled together (or pooled, if you'd rather). Then this big pile of mortgage debt becomes the basis of securities (those mortgage-backed securities we mentioned before), which can then be sold on the open market.

Having a mortgage pool provides some diversification, in that a single default by one of the associated homeowners doesn't cause a major threat to securities issued based on the pool. However, this diversification is limited.

All the mortgages in a pool are similar...that's part of the plan. They likely have the same risk, duration, geographic area, size, type of collateral (a house), color of paper used to sign the documents, etc. This means that all the mortgages will react in a similar way to market forces. An economic downturn that increases the number of home defaults will impact all the homeowners that contribute to the pool in the same way. It's like a school of sardines when a shark enters the area...they all turn the same direction at once.

Since everything reacts in a similar way to market influences, when things go bad, they go bad for all the pool contributors. In that case, it's not diversification. It's more like...gasoline on a fire.

Hence the issues that came up in the mortgage meltdown that led up to the 2007-2008 financial crisis. When the market turned, it turned for everyone in the same way. Many pools became completely toxic, because they weren't filled with completely independent actors. They were filled with a bunch of situations likely to react exactly the same to a bad housing market...i.e. with people who stopped paying their mortgages.