The pool of loans underlying the mortgage bond conformed to the standards, in their size and the credit quality of the borrowers, set by one of several government agencies: Freddie Mac, Fannie Mae, and Ginnie Mae.-The Big Short: Inside the Doomsday Machine by Michael Lewis

I've searched meaning of the word "underlying" and found several meanings, but I'm not sure of which one is correct one.

a)Lying or situated under something. [Lexico.com]

b)used to describe something on which something else is based [Cambridge dictionary]

c)anterior and prior in claim [Merriam-Webster]

  • 1
    Personally, I'd expect underpinning here, but what do I know? Presumably, the "mortgage bond" is a big pot of money to be lent out to potential home-buyers. And that big pot of money itself came from loans from lenders (banks, private investors, etc.). So those loans from cash-rich lenders underlie / underpin / support / give rise to / create / maintain the pot of money to be lent on to cash-poor mortgagees. May 24 at 11:35
  • I'd agree underpinning seems more common, but it has more of a sense of something acting as a guarantee, which is in conflict with the subject of The Big Short (unsecured or inadequately secured loans causing financial disaster), so maybe the filmmakers wanted to emphasise a looser connection between bond and mortgage.
    – Stuart F
    May 24 at 11:53

Underlying is often used when speaking of financial derivatives. The derivative financial instrument (say a bond pool of mortgages or a call option on a stock) derives some of its value from the underlying instrument (the mortgages or the stock).

The closest meaning is the OP's second definition.

used to describe something on which something else is based

Here's a description of a bond pool, also called a Mortgage-Backed Security (MBS):

GNMAs are mortgage-backed securities that are issued by the Government National Mortgage Association (a.k.a. Ginnie Mae) and guaranteed by the federal government. For those not familiar with mortgage-backed securities, Vanguard describes them this way:

MBS are an investment in a pool of mortgage loans, which are the underlying asset and provide cash flow for the securities. MBS are commonly referred to as “pass-through” securities, as the principal and interest of the underlying mortgage loans “passes through” to the investor. All bondholders receive a monthly pro-rata distribution of principal and interest over the life of the security.

Source: How Do GNMA Bonds Work?

An important point that Michael Lewis was making in The Big Short is that the bond pools should have derived their credit quality from the underlying mortgages. The rating agencies, Moody's and S&P, should have lowered the ratings of the bond pools to reflect the lower ratings of the underlying mortgages.

The falling of the Jenga block tower in the movie was a vivid way to describe the consequences of failing to have the derived instruments correctly reflect the value and quality of the underlying instruments.

  • Thanks, It helped a lot.
    – ice man
    May 24 at 13:57

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