Carty & Company, Inc.
Mortgage Backed Securities
What are mortgage-backed securities?
Mortgage-backed securities (MBS or Mortgage Backs) are bonds secured by home and other real estate loans. Mortgage backs are created when a number of these loans, usually with similar characteristics, are pooled together. That pool is then sold to a federal government agency like Ginnie Mae or a government sponsored-enterprise (GSE) such as Fannie Mae or Freddie Mac, or to a securities firm to be used as the collateral for the new MBS. MBS carry the guarantee of the issuing organization to pay interest and principal payments on their mortgage-backed securities. While Ginnie Mae’s guarantee is backed by the “full faith and credit” of the U.S. government, those issued by GSEs are not.
Unlike a traditional fixed-income bond, most mortgage-backed bondholders receive monthly—not semiannual— interest payments benefiting the institution’s cash flow needs.
Since the creation of GNMA, FHLMC, and FNMA (pronounced Ginnie Mae, Freddie Mac, and Fannie Mae) Carty & Company, Inc. has participated in the mortgage-backed securities market. Many mortgage bankers depend on the financial services industry to make their products available to the secondary market. Our institutional buyers include banks, money managers, trust departments, credit unions, as well as pension funds, and insurance companies. The mortgage-backed securities market is very large and complex with all the major dealers as participants. However, with the expertise and experience of our competent staff, we feel that we offer our customers the best prices and service available in the broker/dealer community.
Understanding Mortgage-Backed Securities
A mortgage-backed security is only as sound as the mortgages that back it up. These securities turn the bank into an intermediary between the homebuyer and the investment industry. For example, a bank can grant a mortgage to its customers and then sell the mortgage to a discount for inclusion in a mortgage-backed security. The banks will record the sale as a plus on their balance sheet and will lose nothing if the original homebuyer defaults at some point down the road.
Types of Mortgage-Backed Securities
There are two common types of mortgage-backed securities:
- Pass-throughs
- Collateralized Mortgage Obligations, or CMOs
Pass-throughs
Pass-throughs are structured as trusts in which mortgage payments are collected and then passed through to investors. Typical maturity rates are five, 15, or 30 years. Depending on the principal payments on the mortgages that make us the pass-through, the maturity date may be less than originally stated.
Collateralized Mortgage Obligations
CMOs consist of a variety of securities known as slices, or trances. They are given credit ratings that determine the rates returned to investors.
How Mortgage-backed Securities Affect Financial Crisis
Mortgage-backed securities played a crucial role in the financial crisis beginning in 2007, which in retrospect seems inevitable. A rapid increase in home prices and the growing demand for mortgage-backed securities encouraged banks to lower their lending standards and drive consumers to jump into the market.
Crisis
With Freddie Mac and Fannie Mae aggressively supporting the mortgage market, the quality of all mortgage-backed securities declined. Shortly after, housing prices peaked. Subprime borrows, or those who were accepting due to lowering requirements started to default. More and more people began walking away from their mortgages as their homes were worth less than their loans. The increase in non-payments meant that many mortgage-backed securities were vastly overvalued. These losses piled up, and many banks found themselves on the brink of insolvency.
Today
After a bailout from the U.S. Treasury and a changing market, mortgage-backed securities are still bought and sold today. People will generally pay their mortgages if they can, and defaulting is not as common as it was during the economic downturn. The Fed still owns huge chunks of the market for mortgage-backed securities, but it is gradually selling its holdings.
For more information on the many types of mortgage securities: