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Residential Mortgage Lending: Principles and Practices, 6e Chapter 5 SECONDARY MORTGAGE MARKET

© 2012 Cengage Learning Objectives After completing this chapter, you should be able to: – Distinguish between the primary and secondary mortgage market. – Describe the economic functions of the secondary mortgage market. – Understand the similarities and differences in different types of residential mortgage-backed securities issued in the secondary market. – Identify the roles and activities of the major players in the secondary mortgage market. – Summarize the mortgage purchase programs used by each of these secondary market institutions and how they generate income for each party involved. – Explain the trends that evolved in secondary market activity in the past twenty years. – Understand the secondary mortgage market dynamics that occurred in the recent mortgage crisis.

© 2012 Cengage Learning Functions of Secondary Mortgage Market A. Provide liquidity B. Moderate cyclical flow of mortgage capital C. Assist flow of capital from surplus to deficit areas D. Lessen geographical spread in interest rates and allow diversification

© 2012 Cengage Learning Secondary Mortgage Market Federal National Mortgage Corporation (better known as Fannie Mae) Federal Home Loan Mortgage Corporation (better known as Freddie Mac) Federal Home Loan Banks (offering the Mortgage Partnership Finance Program or MPF) Government National Mortgage Association (better known as Ginnie Mae)

© 2012 Cengage Learning Fannie Mae's Earnings Net interest income - the spread between its borrowing costs and the yield on its mortgage investment Guaranty fees - the fee charged for providing a guaranty that the principal and interest will be paid to investors holding their MBS Fee income - from financial and information services such as the issuance of Real Estate Mortgage Investment Conduits (REMIC)

© 2012 Cengage Learning Reasons for Private Secondary Mortgage Market Deregulation and a shift in political sentiment to less government. Government-related agencies borrowing in the capital markets at the same time as excessive federal deficits drive up interest rates and thus crowd some other borrowers out. Perception of unfair competition, since government- related agencies borrow more cheaply than private companies. Growth of primary and secondary mortgage markets provide profit opportunities for private entities.

© 2012 Cengage Learning PRIVATE SECONDARY MORTGAGE MARKET ● Wall Street investment banks ● Commercial banks ● Thrifts: Savings banks and savings and loan associations ● Life insurance companies ● Pension funds ● Private conduits ● GSEs (Fannie Mae, Freddie Mac, FHLB)— as investors

© 2012 Cengage Learning A Period of Expansion The first ten years of the new millennium saw rapid expansion, decline disruption, and restructuring in the secondary mortgage market—clearly the most volatile period since its inception.

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Rapid Decline Sadly, the secondary mortgage market collapse was just as abrupt as its rise, and the impact of its decline more severe, helping to push the United States economy into its worst economic period in 70 years. The scope of financial loss and its effects shook economies worldwide.

© 2012 Cengage Learning Fraud in the Secondary Mortgage Market third-party originations, where the lender does not have complete control over the origination process. credit rating agency due diligence and when examining the underlying loans in the MBS. strength of the guarantee of the institution issuing the private-label security.

© 2012 Cengage Learning What Do You Think? What economic functions are performed by the secondary mortgage market? Identify the major players in the secondary market and their specific roles. What types of mortgage loans will Fannie Mae and Freddie Mac buy?

© 2012 Cengage Learning What Do You Think? What factors helped cause the secondary mortgage market crisis in 2008? What is “credit enhancements”? Why is it important to today’s market? What does “recourse” mean? How can a lender avoid this risk?

© 2012 Cengage Learning What Do You Think? What are mortgage-backed securities? Why are they so important? What are the important differences between GSE-issued and privately-issued MBSs?

© 2012 Cengage Learning Check Your Understanding 1.Both Fannie Mae and Freddie Mac are private corporations. 2.Fannie Mae and Freddie Mac combined own between percent of all secondary mortgage market issues annually. 3.Although both Fannie Mae and Freddie Mac are successful, Fannie Mae purchases more conventional loans than any other type of mortgage loan. 4.Ginnie Mae was once a part of Freddie Mac.

© 2012 Cengage Learning Check Your Understanding 5.Fannie Mae purchases all types of single-family mortgages loans but never multi-family. 6.Freddie Mac was originally formed to serve members of the Federal Reserve System. 7.Recourse can be defined, as the contingent liability a seller of a mortgage loan has to repurchase the loan if the sale breaches on one of the warranties the seller made. 8.A mortgage-backed security is a capital market security.