Mortgage-backed securities

Mortgage-backed securities
Jacob Cornelisz. van Neck (Necq) · Public domain · source
Name	Mortgage-backed securities
Introduced	1970s
Market	New York Stock Exchange; London Stock Exchange
Asset type	Debt security

Mortgage-backed securities are tradable financial instruments backed by pools of residential or commercial mortgage loans originated by Wells Fargo, JPMorgan Chase, Bank of America, Citigroup, and other lenders. Developed in the 1970s through initiatives involving Salomon Brothers, Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Government National Mortgage Association, these instruments transformed funding for housing and influenced capital flows across markets such as Wall Street, London, Tokyo Stock Exchange, and Hong Kong Stock Exchange. Their complexity and interconnection with institutions like Goldman Sachs, Merrill Lynch, Deutsche Bank, UBS, and Credit Suisse have linked them to major regulatory responses including reforms by the Securities and Exchange Commission and actions under the Dodd–Frank Wall Street Reform and Consumer Protection Act.

Overview

Mortgage-backed securities are created when originators such as Countrywide Financial or GMAC (now Ally Financial) pool loans and sell interests to issuers like Fannie Mae, Freddie Mac, or private-label conduits managed by BlackRock and PIMCO. Investors ranging from Vanguard Group and State Street Corporation to hedge funds like Bridgewater Associates and Paulson & Co. buy tranches structured by firms including J.P. Morgan, Citigroup, and Morgan Stanley. Markets for these securities interact with benchmarks such as the LIBOR (historically), the Federal Reserve's policy rates, and indices maintained by Bloomberg and S&P Global. Trading venues and custodians like Depository Trust & Clearing Corporation and Euroclear support liquidity, while rating agencies including Moody's Investors Service, Standard & Poor's, and Fitch Ratings assess credit risk.

Types and Structure

Common forms include pass-through securities and collateralized mortgage obligations assembled by securitizers like Lehman Brothers (historically) and Barclays. Mortgage pools comprise fixed-rate and adjustable-rate loans from lenders including Chase and Ally Financial; their cash flows are structured into tranches—senior, mezzanine, and equity—sold to investors such as Allianz, AXA, and sovereign wealth funds like Government Pension Fund of Norway. Residential mortgage-backed securities originated via Federal National Mortgage Association and Freddie Mac differ from commercial mortgage-backed securities issued by entities like Goldman Sachs for loans on properties managed by firms like Blackstone. Legal structures often involve special-purpose vehicles inspired by practices at Dai-Ichi Kangyo Bank and Mitsubishi UFJ Financial Group to isolate bankruptcy risk.

Issuance and Securitization Process

Securitization begins with originators such as Countrywide Financial or Wells Fargo underwriting loans, documented via servicers such as Ocwen Financial or Mr. Cooper. Loans are transferred to trustees like Bank of New York Mellon or Wilmington Trust and pooled into trusts sponsored by issuers including Fannie Mae, Freddie Mac, Ginnie Mae, or private investment banks like Credit Suisse. Underwriters such as Deutsche Bank and UBS market the tranches to investors including pension funds like CalPERS and asset managers like BlackRock. Legal frameworks often reference statutes and programs administered by Department of Housing and Urban Development and involve compliance with disclosures overseen by Securities and Exchange Commission filings.

Pricing, Valuation, and Risk

Valuation models used by banks like Goldman Sachs and asset managers such as PIMCO employ discounted cash flow techniques, prepayment models influenced by interest-rate scenarios from the Federal Reserve and volatility metrics similar to those tracked by CBOE indices. Risks include credit risk assessed by Moody's Investors Service and Standard & Poor's, interest-rate risk tied to policies from the Federal Reserve and central banks like the European Central Bank, and liquidity risk manifested during episodes affecting exchanges such as the New York Stock Exchange. Hedging strategies use derivatives traded on venues like Chicago Mercantile Exchange and counterparties such as Bank of America Merrill Lynch, while stress testing has been promoted by regulators like the Office of the Comptroller of the Currency and international bodies like the International Monetary Fund.

Regulatory Framework and Market History

Early development involved Salomon Brothers innovations and policy support from Department of Housing and Urban Development and Federal National Mortgage Association. Regulatory attention intensified after events like the Savings and Loan crisis and later the Global Financial Crisis of 2007–2008, prompting legislative responses such as the Dodd–Frank Wall Street Reform and Consumer Protection Act and enforcement actions by the Securities and Exchange Commission and Department of Justice. Agencies including Federal Housing Finance Agency oversee Fannie Mae and Freddie Mac, while capital and accounting standards from Basel Committee on Banking Supervision and Financial Accounting Standards Board affect bank holdings. Market participants such as Lehman Brothers and Bear Stearns played central roles in historical stress events that reshaped regulatory architecture.

Role in Financial Crises and Economic Impact

Mortgage-backed securities were pivotal in the Global Financial Crisis when defaults on subprime loans originated by lenders like New Century Financial and Ameriquest led to losses at institutions including Lehman Brothers, Bear Stearns, AIG, and Citigroup. The crisis prompted emergency interventions by the Federal Reserve and Treasury actions under officials such as Henry Paulson and Ben Bernanke, and reshaped practices at firms like Goldman Sachs and Morgan Stanley. Economic consequences affected housing markets in regions such as California, Florida, and Arizona and led to reforms in mortgage origination overseen by the Consumer Financial Protection Bureau. Subsequent litigation involved major banks and resulted in settlements with entities like the Department of Justice and regulators including the Securities and Exchange Commission.

Category:Financial markets