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.
Related or Semi-related Video
Finance: What is a Mortgage?345 Views
Finance allah shmoop shmoop What is a mortgage Well people
a mortgage is just dead it's alone but one with
special tax treatment For most people simply put Any interest
you pay on a mortgage to buy a home is
tax deductible Morty morton's inputs down a hundred thousand bucks
to buy a home that costs four hundred big ones
his mortgages three hundred grand at five percent interest per
year So that's fifteen thousand dollars a year he pays
to rent the money from the bank which he uses
to buy his dream home with the loop de loop
waterslide Morty earns one hundred grand a year and pays
tax on his last fifteen thousand of earnings soas faras
The irs is concerned since morty can deduct his fifteen
thousand dollars in interest against his earnings he does not
in fact earn taxable wages of one hundred grand annually
Instead he earns taxable wages of eighty five thousand dollars
a year Essentially with government is doing is sharing in
some of the cost of renting the money Taub i'm
ortiz home well why would the u s government be
so charitable Well because home ownership has been integral part
of the american dream since the u s of a
i po'ed in seventeen seventy six easy access to mortgages
and then home buying can be a hugely beneficial asset
In the vast majority of cases homes create family stability
a store of wealth and tax dollars for local schools
in the form of real estate taxes So don't feel
bad about splurging on that water slide there Morty Just 00:01:42.93 --> [endTime] remember you're doing it for the kids Hello
Up Next
What is an Adjustable-Rate Mortgage (ARM)? An adjustable-rate mortgage is a mortgage that has a changing interest rate. Whatever it changes to is b...
An interest-only mortgage is a mortgage on which you only pay the rent on money borrowed, rather than on the principal.
What's a second mortgage? Easy: it comes after a first mortgage. Hit play for more details.
With a reverse mortgage, payments go in the opposite direction of a normal mortgage, where you pledge your home as an asset, and receive $ each month.