US MBS market.

• Author: Franscini, Mathilde
• Position: Mortgage backed securities

Securitisation in its present form has been originated in the mortgage markets in the United States. It has been promoted with the active support of the government. The latter wanted to promote secondary markets in mortgages to allow liquidity for mortgage finance companies, critical factor in the development of home ownership. We review the existing US MBS structures.

1. FEDERAL AGENCIES

   The MBS market is dominated by three agencies that purchase mortgage loans from banks, saving institutions and mortgage companies. They are the Government National Mortgage Association (GNMA or "Ginnie Mae"), the Federal Home Mortgage Corporation (FHLMC or "Freddie Mae") and the Federal National Mortgage Association (FNMA or "Fannie Mae").

   As part of the Department of Housing and Urban Development, Ginnie Mae is a federal institution. MBS issued by Ginnie Mae are guaranteed by the full faith and credit of the United States government with respect to timely payment of both interest and principal. For the guarantee, Ginnie Mae receives a fee. Freddie Mae and Fannie Mae are commonly referred to as agencies of the US government. Their stocks trade on the NYSE and they are quasi private corporations. Although their guarantee does not carry the full faith and credit of the US government, the market believes that there is an "implicit" state guarantee.

   Ginnie Mae was the first one to buy mortgages from mortgage companies and to convert them into pass through securities--this was in 1970. Fannie Mae and Freddie Mae jumped in later.

   In addition to securities issued by the three agencies, there are also MBS issued by private banks or corporations ("private conduits"). The MBS issued by agencies are restricted to mortgage loans which satisfy a certain standard of underwriting. Such mortgages are called conforming mortgages. The private conduits, on the other hand, can also bundle loans which do not satisfy those underlying standards. Such mortgages are called non-conforming.

2. MARKET DEVELOPMENT

   The US MBS market has experienced phenomenal growth over the past 20 years. The total outstanding volume of MBS has increased from about USD 100 bn in 1980 to about USD 3 tn in 2000. Nowadays, MBS form a major component of the US fixed income market.

   Explanation for this rapid growth can be found on the "offer side" as well as on the "demand side".

   1. Offer drivers

      On the offer side, mortgage originators became much more disposed to sell loans into the secondary market after the high interest rates environment of the late 1970s and early 1980s, when the disadvantages of holding fixed-rate long-term loans in their portfolio became apparent. The growing market share of mortgage bankers, who have little interest in keeping mortgage loans in their balance sheet also contributed to their increased securitisation. As a general rule, many institutions became more and more aware of the benefits of the new process as a way to turn illiquid assets into liquid securities and hence improve overall balance sheet management.

      The federal government-through its three "federal" housing finance agencies--has played a crucial role in the development of MBS in the US. These federal housing financing agencies were created to facilitate the flow of mortgage capital--in terms of cost and availability--and, hence, to ensure that lenders had adequate funds to make new mortgage loans.

   2. Demand drivers

      On the demand side, MBS represent nowadays an important portion of fixed-income holdings for many types of investors. This popularity is...