Mortgage-Backed Securities

During the early 1970s, the process of securitization began in financial markets in the United States. Securitization transforms assets and liabilities that are illiquid and costly to sell into capital market instruments. This process enables owners of assets and debts to market their claims, saving considerable amounts of resources. Similarly, this process permits investors to purchase interests in various types of assets in smaller portions or shares, removing one of the traditional investment disadvantages (“lumpiness”) of real asset markets. Securitization is also best viewed as a mechanism for providing liquidity to markets where liquidity has traditionally been a structural problem.

Many commentators view the securitization market as the primary reason for the collapse of the housing market in the late 2000s. They claim that the greediness of Wall Street investment bankers to form new mortgage-backed securities (MBSs) to sell around the world led to the bust. Without the MBS market, there would have been nowhere for mortgage originators to sell their subprime loans, they reason, and the reckless lending in the prehousing bust period (about 2004–2007) would not have occurred. There is no doubt that the MBS market for residential property grew dramatically during this period, and given the size of the U.S. mortgage market and expanding homeownership rates during the period, there was an enormous new market created for securities. For Wall Street firms, this represented a generational opportunity for professional fees.

No doubt there is some truth to the claim that mortgage originators and investment bankers helped provide an environment for the housing finance bubble of the 2000s. However, so did many other players including the Federal Reserve Bank, the real estate brokerage community, the real estate appraisal community, the rating agencies, and others. It is generally agreed that there is plenty of blame to go around. A more serious matter is to place blame for the crisis on securitization per se, something that is dangerous and likely incorrect. The creation of mortgage-backed securities is an important historical development in U.S. (and now many international) financial systems. The benefits to the public are a bit hidden and subtle but transformational in nature. MBSs are indeed a step toward complete mortgage markets with benefits extending to millions. What occurred in the recent financial crisis deeply affected the structure of the mortgage finance system, including mortgage-backed securities now fundamentally a part of the system. It is a complicated story of unregulated players, economic greed, mismeasurement of risk, and moral hazard problems with the regulation of the players involved. It is also a story where the technicalities with the instruments became so difficult that players in the system lacked the skills or technical expertise to figure out what was going on. The fallout from the financial crisis is still being felt to this day.

One of the major forms of securitization in real estate housing markets is the use of mortgage-backed securities, or MBSs. These instruments were initially supported by the Government National Mortgage Association (GNMA, or “Ginnie Mae”) in the early stages of development (during the early 1970s). Later, former government agencies (now referred to as government supported enterprises, or GSEs) took over as semiprivate firms: Federal National Mortgage Association, or “Fannie Mae,” and Federal Home Loan Mortgage Corporation, or “Freddie Mac”). Fannie and Freddie evolved into the major government-backed institutions that supported the secondary mortgage market through purchase and placement and formed a key part of the residential mortgage market. Now in receivership, the future roles of these institutions are undecided and remain an open question for the years ahead.

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