Secondary Mortgage Markets:

An Introduction
Marshall Tracht

Copyright © 2011 New York Law School

All Rights Reserved
 The Traditional Model

3% 6%
Deposits Loans

Local
Local Neighborhood
S&L or Bank Mortgage
Depositors
Borrowers
 The Traditional Model

3% 6%
Deposits
Loans
Mortgage
Depositors Borrowers

• Supply / Demand imbalances

• Regional Disparities

• “Credit Crunches”
 Regional Imbalances

Sunrise S&L Tribeca Savings Bank

• Has made 1,000 loans, • Has $50 million in deposits, but no
$100,000 each qualified borrowers
•Has more borrowers, but no
more money
 Solution: Secondary Mortgage Market
(Buying and Selling Mortgages)

500 Mortgages

$50 million

Sunrise S&L Tribeca Savings Bank

•Sells 500 mortgages to
•Buys 500 mortgages from SS&L
Tribeca

•But: Which ones?

 Solution: Secondary Mortgage Market
(Buying and Selling Mortgages)

500 Mortgages

$50 million

Sunrise S&L Tribeca Savings Bank

•Sells 500 mortgages to •Buys 500 mortgages from SS&L
Tribeca

•But: Which ones?

 Solution: Secondary Mortgage Market
(Buying and Selling Participations in Mortgages)
Undivided Half
Interest in Mortgages

$50 million

Sunrise S&L Tribeca Savings Bank

•Sells undivided interest in all •Buys half interest in all of the
1,000 mortgages to Tribeca mortgages in the pool

•Mitigates lemons problem •Of every dollar Sunrise collects,

it sends 50 cents to Tribeca
 Solution: Secondary Mortgage Market
(Borrowing Against Mortgages)

Security Interest in Pool

of 1,000 mortgages

$50 million loan

Sunrise S&L
Tribeca Savings Bank
•Borrows $50 million
•Makes a secured $50 million
•Gives Tribeca security loan
interest in its assets – the
•But: Lower return than on
mortgages
mortgages?
•But: Higher interest rate than
on deposits?
 Solution: Secondary Mortgage Market
(Selling Mortgage Backed Bonds to Public Investors)
Bonds secured by a
pool of mortgages

$50 million

Sunrise S&L Public Investors

•Sells $50 million in bonds, •Buy bonds secured by the
secured by its mortgages mortgages.

•Investors accept lower interest •Higher return than investors can get
rates than Tribeca would charge. on deposits.

•SS&L has additional $50 million

in debt on its books.
 Solution: Secondary Mortgage Market
(Selling Mortgage Participations to Public Investors)
Pro rata interests in pool
of 500 mortgages

$50 million

Sunrise S&L Public Investors

•Sells $50 million in mortgage
participations
•Investors pay more than Tribeca
•No longer has additional $50
million in debt on its books!
•Buy participation certificates (PCs):
undivided ownership interests in the
pool of mortgages
•Higher return than investors can get
on deposits.
But what about the lemons?
GSEs to the Rescue
 Government-Sponsored Enterprises (GSEs)
FNMA / Fannie Mae and FHLMC / Freddie Mac
 Tweedledee and Tweedledum (for our purposes)

 Stockholder owned, profit-seeking companies sponsored by Federal

Government

GNMA / Ginnie Mae

• Division of HUD
• Handles low income, multifamily financing
 Solution: Secondary Mortgage Market
(Securitizing Mortgages: Modified PCs)

50
0

i on Tribeca
l
Mo

SS&L m il or Public
rtg

0
$5
$5

in Investors
ag

n s
llio Pas tie
0

i s
es

m d ri
m

0 e cu
$5 difi Se
illi

Mo ugh
o
n

ro
Th
 Solution: Secondary Mortgage Market
(Securitizing Mortgages: Modified PCs)

50
0

i on Tribeca
l
Mo

SS&L m il or Public
rtg

0
$5
$5

in Investors
ag

n s
llio Pas tie
0

i s
es

m d ri
m

0 e cu
$5 difi Se
illi

Mo ugh
o
n

ro
Th
 Solution: Secondary Mortgage Market
(Buying and Selling Mortgages: Modified PCs)

50
0M

SS&L li lio
n Fin. Inst.
or

m
or Public
$5

tga

0
$5
0

in Investors
ge

n
m

s
i llio Pas ties
s
illi

0 m d
u ri
on

$5 difi See c
Mo ugh
ro
Th

“Conforming loan” standards

•Credit Standards
•80% LTV or lower, else PMI
•Loan Limit (417k / 729k)
X
 How Does Anyone Make Money?
(Buying and Selling 6% Mortgages
Fannie Mae as guarantor)

50 din
Yi
0M g
Tribeca
e

n
l

o
or 5.75
tga %
il li or Public
SS&L 0 m
Investors
$5 in
$5

ge
n s
llio as ties
0

i
s
m d P ri
m

0 u
$5 difie Sec .5%
illi

• Origination Fees
Mo ugh ng 5
on

• Servicing Fees ro eldi

h
T Yi
• Yield Spread

0.25% Guaranty Fee

 How Does Anyone Make Money?
(Fannie Mae as investor)

50 din
Yi
0M g
e

n Public
l

o
or 5.75
tga %
il li
SS&L m Investors
0
$5
$5

ge
B B
M
0

s
n
l li g 4 %
o
m

i
m din
illi

0 l
$5 Yie
on

Profit on spread between Mortgage

Yields and cost of its bonds
 Do we need the GSEs?

50 din
Yi
0M g
e

n Public
l

o
or 5.75
tga %
il li
m Investors
SS&L 0 B
$5
$5

B
ge
n M
0

s
i llio
m

m
illi

0
$5
on

Can’t investment banks raise

money by selling bonds and
buy mortgages from lenders?
 Do we need the GSEs?
Wall Street Can’t Compete

50 din
Yi
0M g
e

n Public
l

o
or 5.75
tga %
il li
SS&L m Investors
0 B
$5
$5

ge
MB
0

n
s
llio 4%
m

i
m ing
illi

0
$5 Yield
on

Due to higher capital costs, investment

banks can’t compete with GSEs
 Do we need the GSEs?
Wall Street Can’t Compete . . . on conforming loans

50 rtga 8.7
Mo ldin
0 S ge
Yi
e

ub i on Public
pr il l
g
s
SS&L im 0 m k ed ) Investors
e $5 ac Os
$5

B
5%

ge (CM
0

a
rtg ities
m

o
M cur
illi

Se
on

But GSEs are only allowed to

purchase conforming loans!
 Wall Street’s Role
The non-conforming markets

50 rtga 8.7
Mo din
0 S ge
Yi
e

ub
l
Mortgage
n Public

pr
o
$5

g
Companies il li
s
im
Investors
0

m
e
and Brokers 3
m

$5
d
5%
ke s)
illi

c
a O
B
on

age (CM
o rtg ities
M cur
Se

Wall Street finances massive growth of the Jumbo,

Alt-A and Subprime Mortgage Markets: “The
Democratization of Credit” / “Predatory Lending”
How did Fannie Mae and Freddie Mac Go Under???
• Insurance losses: Underpriced guaranty fee, took huge losses on
conforming loans

• Investment Losses: Although not allowed to directly purchase

nonconforming mortgages . . . invested in CMOs, issued by others, backed
by subprime mortgages.

• Now in federal conservatorship, but are keeping the residential market afloat

• The future is up for grabs