The Secondary Mortgage Market

1
Chapter 3

• The Secondary Mortgage Market

2
Learning Objectives
3-1

• Explain why the secondary mortgage market exists
  and how it developed
• Describe how the secondary mortgage market works
• List the major secondary mortgage market agencies
• Indicate the size of this market relative to all
  real estate lending

3
Why Does the Secondary Mortgage Market Exist?
3-2

• Severe liquidity problems for financial
  institutions resulting from inability to sell
  assets quickly
• Mortgage assets were not homogeneous
• Buyers were concerned with default risk
• Regional mismatch of supply and demand of capital

4
Secondary Mortgage Market Cont.
3-3

• Secondary mortgage market solved these problems
• The federal government encouraged development of
  the secondary market by overriding state laws

5
3-4
Mortgage-Related Securities
Credit Enhancement

• Less default risk than underlying mortgages

Double Taxation

• MRSs need to avoid double taxation

Investor-Friendly Cash Flows

• MRSs need to tailor cash flows to fit investors
  needs

6
Types of Mortgage-Related Securities
3-5

• Mortgage Pass-Through Securities
• Mortgage-Backed Bonds
• Collateralized Mortgage Obligations

7
Mortgage Pass-Through Securities
3-6

• Investors have an undivided interest in the
  mortgage pool
• Investors receive mortgage payments and prepay
  rents the same as the lender
• Cash flows can be uncertain due to unpredictable
  prepayments

8
Mortgage Backed Bonds
3-7

• Payments are similar to corporate bonds
  semiannual interest with face value paid at
  maturity
• Yield is less than the average yield of mortgage
  in the pool
• Bond rating is based on
• the quality of the mortgage in the pool
• the interest rate spread of mortgages in pool and
  the MBB

9
Bonds Cont.
3-8

• Bond Rating based on
• the likelihood of prepayment
• the geographical diversification of mortgage in
  the pool
• the amount of over-collateralization

10
Collateralized Mortgage Obligations
3-9

• Most drastic re-arrangement of the cash flows
• Different bond classes called tranches
• Stripped mortgage-backed security
• Interest-only strip
• Principal-only strip

11
Secondary Mortgage Markets Agencies and Firms
3-10

• Federal National Mortgage Association (Fannie
  Mae)
• Government National Mortgage Association (Ginnie
  Mae)
• Federal Home Loan Mortgage Corporation (Freddie
  Mae)
• Federal Credit Agencies
• State and Local Credit Agencies
• Private Firms

12
Federal National Mortgage Association
3-11

• Established in 1938 to provide secondary market
  support for FHA loans
• Re-charting in 1954 transformed Fannie Mae into
  private entity
• Purchases mortgages and issues mortgage-related
  securities
• Allowed to start purchasing conventional
  mortgages in 1970

13
Government National Mortgage Association
3-12

• Established in 1968 and overseen by HUD
• Management and liquidation of previously
  originated (before 1968) Fannie Mae mortgages
• Subsidizes the cost of low-income housing
• Tandem plan makes low-interest loans to qualified
  families

14
GNMA Cont.
3-13

• Guarantees pass-through securities in timely
  payment of interest and principal
• Does not purchase mortgages or issue securities

15
Federal Home Loan Mortgage Corportation
3-14

• Established in 1970 to create a secondary market
  for conventional mortgages
• Authorized to purchase conventional, FHA and VA
  mortgages
• Obtains funds by issuing
• Discount notes and debentures
• Mortgage participation certificates
• Collateralized mortgage obligations
• Guaranteed mortgage certificates

16
Federal Credit Agencies
3-15

• Farm Credit System
• Farm Credit Assistance Financial Corporation
• Federal Agricultural Mortgage Association
• Farmers Home Administration
• Financing Corporation
• Federal Financing Bank

17
State and Local Credit Agencies
3-16

• State housing finance agencies fund FHA and VIA
  mortgages
• Participate in affordable housing initiatives

18
Regulation of Government Sponsored Enterprises
3-17

• Government sponsored enterprises
• Fannie Mae
• Freddie Mac
• Are not official departments of the U.S.
  government but enjoy the backing of the federal
  government
• Issue debt to purchase long-term mortgages