Securitization of Mortgages

PROBLEMS FACED WHEN SELLING MORTGAGES IN THE SECONDARY MARKET:

 Mortgages are usually too small to be wholesale instruments

 Mortgages were not standardized
 Mortgage loans are relatively costly to service
 Mortgages have unknown default risk

* These problems inspired the creation of mortgage-backed security or securitized mortgage.

MORTGAGE-BACKED SECURITY

- An alternative to selling mortgages directly to investors is to create a new security backed

by (secured by) a large number of mortgages assembled into what is called a mortgage
pool.
- Securitization – when a trustee, a bank or a government agency, holds the mortgage pool

Mortgage pass-through

- Most common type of mortgage-backed security

- A security that has the borrower’s mortgage payments pass through the trustee before
being disbursed to the investors in the mortgage pass-through.

TYPES OF PASS-THROUGH SECURITIES

 Government National Mortgage Association (GNMA) Pass-Through

 Federal Home Loan Mortgage Corporation (FHLMC) Pass-Through
 Private Pass-Through (PIPs)

SUBPRIME MORTGAGES
- Subprime loans – are those made by borrowers who do not qualify for loans at the usual
market rate of interest because of a poor credit rating or because the loan is larger than
justified by their income

THE REAL ESTATE BUBBLE

- The mortgage market was heavily influenced by the real estate boom and bust between the
years 2000 and 2008.
- Real estate speculators were a second driver of the price bubble.
- The ability to obtain zero down loans allowed them to buy property easily and with little
committed capital.
- The securitized mortgage was initially hailed as a method for reducing the risk to lenders by
allowing them to sell off a portion of their loan portfolio. The lender could continue making
loans without having to retain the risk.