RTC Mortgage Blog

Who's Buying Mortgages? 3/24/2011

March 24th, 2011 3:56 PM by Richard T. Cirelli

Who Is Buying Mortgage-Backed Securities Now?


When the mortgage market collapsed a few years ago the Fed stepped in and agreed to buy the Mortgage-Backed Securities (MBS’s) issued by Fannie Mae and Freddie Mac - the two agencies that the Fed was forced to take over when they became insolvent. For 2009 and part of 2010, they were virtually the only buyer of Fannie/Freddie issued MBS’s. The program worked and was essential to keeping mortgage rates low and in providing a source of liquidity for the mortgages originated by Banks and Non-Depository Lenders throughout the U.S.


Are mortgages underwritten in the current environment good investments?


They must be! Since the end of the Government’s MBS purchase program large banks have been the primary buyers of mortgage-backed securities. Most analysts believe that banks will continue to be a leading force in supporting the MBS market in 2011. The demand for agency mortgage-backed securities continues strong, whereas the supply is expected to lessen due to rising interest rates as the economy improves. And now it’s not just the large banks that are buying them. Small banks see them as good investments and they too are buying Fannie/Freddie issued MBS’s.


Q: Why are they good investments now when they weren’t just a couple of years ago?

A: Tighter underwriting guidelines!


Don’t Understand How This Works?


Banks and lenders across the country originate mortgage loans and sell them to Fannie Mae and Freddie Mac, the two agencies that created the standardized underwriting and program criteria. Essentially all mortgages are underwritten to the same standards and at the same rates by all lenders. Fannie and Freddie then bundle these loans with others and create a Mortgage-Backed Security (MBS) – basically a bond backed by hundreds or thousands of new loans underwritten to the same standards. Wall Street investment banking firms are utilized to facilitate the sale of the MBS’s to institutional investors that buy these MBS’s as a long-term investment, much the same as they would buy U.S Treasury’s. By selling the MBS’s, Fannie and Freddie get their money back so they can provide financing for more home owners and homebuyers, thus keeping the flow of money going.


Still Confused?


Enjoy the following parody for a tongue-in-cheek explanation………..


Assume that Heidi is the proprietor of a bar in Detroit. She realizes that virtually all of her customers are unemployed alcoholics and can no longer afford to patronage her bar.

To solve this problem, she comes up with a new marketing plan that allows her customers to drink now, but pay later.


Heidi keeps track of the drinks consumed on a ledger (thereby granting the customers' loans). Word gets around about Heidi's "drink now, pay later" marketing strategy and, as a result, increasing numbers of customers flood into Heidi's bar. Soon she has the largest sales volume for any bar in Detroit.

By providing her customers freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Heidi's gross sales volume increases massively.                                               .

A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases Heidi's borrowing limit. He sees no reason for any undue concern, since he has the debts of the unemployed alcoholics as collateral!                                 . 

At the bank's corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINK BONDS. These "securities" then are bundled and traded on international securities markets.                                                               .

Naive investors don't really understand that the securities being sold to them as "AAA Secured Bonds" really are debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb and the securities soon become the hottest-selling items for some of the nation's leading brokerage houses.

One day, even though the bond prices still are climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar. He so informs Heidi. Heidi then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts.                                                .

Since Heidi cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and Heidi's 11 employees lose their jobs. Overnight, DRINK BOND prices drop by 90%.                                 .

The collapsed bond asset value destroys the bank's liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. The suppliers of Heidi's bar had granted her generous payment extensions and had invested their firms' pension funds in the BOND securities.

They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.                                                        .

Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multibillion dollar no-strings attached cash infusion from the government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, nondrinkers who have never been in Heidi's bar. 

Now do you understand?        

Mortgage Rates This Week:


Mortgage rates have settled down now that there is no new news regarding Egypt, Libya or elsewhere. We enjoyed a rally in MBS’s over the previous couple of weeks which helped push rates down a little. Unless and until something else big happens, the markets will react to other economic events. Nevertheless, rates look great!



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Posted by Richard T. Cirelli on March 24th, 2011 3:56 PM



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