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The Role of the Secondary Market in Mortgage Financing | 2 Limiting the Secondary Market Would Share of Mortgages on Balance Sheets at 30 Percent

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The Role of the Secondary Market in Mortgage Financing | 2 Limiting the Secondary Market Would Share of Mortgages on Balance Sheets at 30 Percent Economic Policy Program Housing Commission The Role of the Secondary Market in Mortgage FinancingTotal Mortgages Outstanding (total $13.1 trillion) Home ($9.8 trillion) 75% Multifamily Residential ($0.9 trillion) 7% Commercial, e.g. offices, retail, factories ($2.2 trillion) 17% Farm ($0.2 trillion) 1% The secondary market for mortgages Mortgages: A $13.1 Trillion Market Notes: plays a critical role in sustainingThese lines The taken current verbatim size of the from mortgage one-­‐line market is totals of L.217 $13.1 trillion, the a healthy housing market. Few largest share of which (75 percent) funds home mortgages. As displayed in Chart 1, another 7 percent of the mortgage homebuyers have sufficient savings market fundsTotal mortgagesMortgages Oonu tapartmentstanding (t obuildingstal $13.1 and other to purchase a home outright, and multifamily properties. trillion) many need to borrow money to buy their first home or to move to another Chart 1: Total Mortgages Outstanding ($13.1 trillion) 1% one. Without the ability to borrow against the value of the home they are 17% purchasing, many prospective buyers 7% would be shut out of the market. The secondary market allows participants 75% in our mortgage system to access capital from investors in the United States and around the world. Any decline in the size of the secondary market would reduce the amount of Home ($9.8 trillion) Multifamily Residential ($0.9 trillion) capital available for mortgage lending Commercial, e.g. offices, retail, factories ($2.2 trillion) and, in turn, borrowers’ options for Farm ($0.2 trillion) financing the purchase of a home. Source: Federal Reserve Bank Flow of Funds. L.217. September 25, 2013. WWW.BIPARTISANPOLICY.ORG The dollar volume of mortgages that originators such as As describedMortgages in Chart Retained 2, at least 59 by percent Originators of mortgages Sold banks into and the credit unions secondary can fund market is determined ($7.7 trillion) by two as of September 2013 were sold to third parties.59%1 By selling Held key on factors: bank (1) their balance capacity to sheets hold mortgages ($4.3 trillion) on their their loans into the secondary market, originators33% are Held own on books; insurance/pension and (2) their ability to fund sell the mortgages balance they sheets ($0.4 trillion) effectively reimbursed for the mortgages they make.3% This Held originate by to others third parties, ($0.7 i.e., trillion) the secondary market. process frees up capital for new mortgage lending,5% allowing additional borrowers to receive home loans. 60 Percent of Mortgage Funding Notes:Comes from the Secondary Market Securitization Broadens InvestorUS-­‐chartered Interest depos instit. + foreign A secondary market for residential mortgages first emerged banking offices in US + banks in US-­‐aff Held in the on 1930s, bank when balance local and sheets = regional mismatches in Securitizationareas + has opened credit up unions the market for mortgages the demand for mortgage credit and the supply of bank to a broaderProperty-­‐casualty universe of investors. insurance Securitization cos + life works depository funds to meet that demand led to surpluses of by aggregatinginsurance mortgages cos + into private pools that, in pension turn, funds + back Insurance mortgage and credit in pension some parts funds = of the country and shortfalls securities.state The & simplest local form govt of MBS retirement is called funds a “pass- in others. Without a system to facilitate the flow of credit to through.”GSEs In + this arrangement, Agency-­‐ investors and in GSE-­‐backed the MBS pools + Sold high-demand to third areas, parties = borrowers in fast-growing communities purchaseABS the issuers rights to a share of the proceeds from the faced higher interest rates and limited financing. To mortgagesHousehold in the pool. sector Over the + life of nonfinancial the mortgages, corporate help address this issue, the federal government bought borrowerbus payments + nonfinancial of interest and principal noncorporate are bus + passed mortgages originated by banks. Today, the secondary on to investors in proportion to their share of the pool. state & local govts + fed govt + finance cos market relies more on securitization (the packaging of Aggregating multiple mortgages into a single pool reduces Other = + REITs individual mortgages into mortgage-backed securities, or investors’ exposure to loss on any single mortgage. The MBS), which plays a critical role in ensuring that qualified ability to easily buy and sell these securities adds further to borrowers have access to mortgage credit throughout the investor demand. system. Most Mortgages Are Sold into the Secondary More complex types of securitization allow the interest and Market Chart 2: Share of Mortgages Sold and Held on principal payment streams to be divided into tranches with Balance Sheets different risk/return characteristics that suit the particular needs and appetites of various kinds of investors. Some 3% MBS, for example, split off the payments of interest from the 5% payments of principal. Other types of MBS pay investors in some of the tranches before others, creating what are called senior/subordinate securities. The investors in tranches that 33% get paid last take a disproportionate amount of the risk, but 59% earn a higher rate of return. Tranches can even be created that have little or no exposure to real estate risk (e.g., the risk of losses related to default and foreclosure, particularly when the value of the property has fallen) but still have interest rate risk (that is, the risk that interest rates will rise and the value of the securities will fall). Sold into the secondary market ($7.7 trillion) Held on bank balance sheets ($4.3 trillion) Held on insurance/pension fund balance sheets ($0.4 trillion) Held by others ($0.7 trillion) Source: Federal Reserve Bank Flow of Funds. L.217. September 25, 2013. 1. Includes home mortgages as well as multifamily residential, commercial, and farm mortgages. This is a conservative estimate and does not reflect mortgages on the balance sheets of banks, insurance companies, pension funds, and other institutions that were purchased from other originators. The Role of the Secondary Market in Mortgage Financing | 2 Limiting the Secondary Market Would share of mortgages on balance sheets at 30 percent. This Likely Reduce Mortgage Originations would require banks to triple both their equity capital (e.g., Assets of by Depository issuing more Institutions stock) and the money raised through Mortgages ($4.3 trillion) 28% 0.2790168 4351.1 The size of the secondary market is determined by deposits or other bank debt. Mortgage-­‐backed securities ($2.0 Liabilities trillion) of Depository 13% Institutions 0.1257246 1960.6 investors’ appetite to purchase mortgages and MBS. If Deposits ($11.0 trillion)* 70% In11018.8 addition,0.7000553 bankers and bank regulators seek to match the Consumer credit less funding ($1.5 were trillion) available through the secondary market,9% 0.0938221 1463.1 Other ($4.7 trillion) 30% maturities4721.1 of0.2999447 their assets and liabilities. The majority of bank Depository then institution fewer or smaller loans mortgages ($2.3 trillion) would likely be originated.15% 0.1486303 2317.8 funding15739.9 (70 percent) is from deposits, which are considered Other credit The only market way to avoid instruments this result ($1.4 would trillion) be for mortgage 9% 0.0925332 1443 Notes: to be of “short duration” (see ). Even if banks were Other assets originators ($2.0 to trillion) expand their balance sheets to hold more 13% 0.1311689 2045.5Chart 4 Deposits = Checkable deposits + small to time increase savings their capacity deposits to hold more + large time deposits mortgages on Reserves at mortgages. Federal Reserve ($2.0 trillion) 13% 0.129104 2013.3 Other = All other categories their balance sheets, they 15594.4are unlikely to hold as large a Notes Such an increase in balance sheets would be difficult proportion of the long-term, fixed-rate mortgages (15- and Other credit to achieve, market particularly instruments L = inia thebilit shorties o frun. De pBanks,ositor yfor Open In stituti o mkt ns 30-year) paper that + borrowers treasury prefer. securities + municipal securities + corporate and foreign bonds + other loans and advances Other assets example, = already devote almost one-third of theirVault $15.6 cash + corporate equities + mutual fund shares + security credit + life insurance reserves + miscellaneous assets All others trillion are portfolios verbatim to mortgages from (see single Chart line of L.109 3). While bank Chart 4: Liabilities of Depository Institutions balance sheets are technically large enough to hold all the mortgages now outstanding ($13.1 trillion), neither the bank 30% nor its regulators would want to see such a concentration of Diversity risk. (Banks also hold of MBS that Assets may or may not of involve Depository real Institutions (total $15.6 trillion) estate risk and generally have different risk characteristics than whole mortgages.) 70% Chart 3: Diversity of Assets of Depository Institutions (total $15.6 Trillion) 13% 28% 13% Deposits ($11.0 trillion)* Other ($4.7 trillion) 9% *Includes checkable deposits, small time and savings deposits, and large time deposits. 13% Source: Federal Reserve Bank Flow of Funds. L.109. September 25, 2013. 15% 9% * Includes checkable deposits, small time and savings deposits, and large time deposits A similar situation exists with insurance companies and Source: Federal Reserve Bank Flow of Funds. L.109. June 6, 2013. pension funds, which also hold a diverse set of assets, although neither property and casualty insurance companies nor federal government retirement funds hold mortgages as a Mortgages ($4.3 trillion) predominate share of their assets. Life insurance companies Mortgage-backed securities ($2.0 trillion) have the largest share of their assets in mortgages—6 Consumer credit ($1.5 trillion) percent of $5.7 trillion, or $348 billion. Insurance companies Depository institution loans ($2.3 trillion) and pension funds (with the exception of government Other credit market instruments ($1.4 trillion) retirement funds) generally have larger investments in MBS.
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