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Chapter 3

Chapter 3. The Secondary Mortgage Market. 3-1. Learning Objectives. Explain why the secondary mortgage market exists and how it developed Describe how the secondary mortgage market works List the major secondary mortgage market agencies

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Chapter 3

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  1. Chapter 3 The Secondary Mortgage Market

  2. 3-1 Learning Objectives • Explain why the secondary mortgage market exists and how it developed • Describe how the secondary mortgage market works • List the major secondary mortgage market agencies • Indicate the size of this market relative to all real estate lending

  3. 3-2 Why Does the Secondary Mortgage Market Exist? • Severe liquidity problems for financial institutions resulting from inability to sell assets quickly • Mortgage assets were not homogeneous • Buyers were concerned with default risk • Regional mismatch of supply and demand of capital

  4. 3-3 Secondary Mortgage Market Con’t. • Secondary mortgage market solved these problems • The federal government encouraged development of the secondary market by overriding state laws

  5. 3-4 Mortgage-Related Securities Credit Enhancement • Less default risk than underlying mortgages Double Taxation • MRSs need to avoid double taxation Investor-Friendly Cash Flows • MRSs need to tailor cash flows to fit investors needs

  6. 3-5 Types of Mortgage-Related Securities • Mortgage Pass-Through Securities • Mortgage-Backed Bonds • Collateralized Mortgage Obligations

  7. 3-6 Mortgage Pass-Through Securities • Investors have an undivided interest in the mortgage pool • Investors receive mortgage payments and prepay rents the same as the lender • Cash flows can be uncertain due to unpredictable prepayments

  8. 3-7 Mortgage Backed Bonds • Payments are similar to corporate bonds: semiannual interest with face value paid at maturity • Yield is less than the average yield of mortgage in the pool • Bond rating is based on: • the quality of the mortgage in the pool • the interest rate spread of mortgages in pool and the MBB

  9. 3-8 Bonds Con’t. • Bond Rating based on: • the likelihood of prepayment • the geographical diversification of mortgage in the pool • the amount of over-collateralization

  10. 3-9 Collateralized Mortgage Obligations • Most drastic re-arrangement of the cash flows • Different bond classes called tranches • Stripped mortgage-backed security • Interest-only strip • Principal-only strip

  11. 3-10 Secondary Mortgage Markets Agencies and Firms • Federal National Mortgage Association (Fannie Mae) • Government National Mortgage Association (Ginnie Mae) • Federal Home Loan Mortgage Corporation (Freddie Mae) • Federal Credit Agencies • State and Local Credit Agencies • Private Firms

  12. 3-11 Federal National Mortgage Association • Established in 1938 to provide secondary market support for FHA loans • Re-charting in 1954 transformed Fannie Mae into private entity • Purchases mortgages and issues mortgage-related securities • Allowed to start purchasing conventional mortgages in 1970

  13. 3-12 Government National Mortgage Association • Established in 1968 and overseen by HUD • Management and liquidation of previously originated (before 1968) Fannie Mae mortgages • Subsidizes the cost of low-income housing • Tandem plan makes low-interest loans to qualified families

  14. 3-13 GNMA Con’t. • Guarantees pass-through securities in timely payment of interest and principal • Does not purchase mortgages or issue securities

  15. Federal Home Loan Mortgage Corportation 3-14 • Established in 1970 to create a secondary market for conventional mortgages • Authorized to purchase conventional, FHA and VA mortgages • Obtains funds by issuing • Discount notes and debentures • Mortgage participation certificates • Collateralized mortgage obligations • Guaranteed mortgage certificates

  16. 3-15 Federal Credit Agencies • Farm Credit System • Farm Credit Assistance Financial Corporation • Federal Agricultural Mortgage Association • Farmers Home Administration • Financing Corporation • Federal Financing Bank

  17. 3-16 State and Local Credit Agencies • State housing finance agencies fund FHA and VIA mortgages • Participate in affordable housing initiatives

  18. 3-17 Regulation of Government Sponsored Enterprises • Government sponsored enterprises: • Fannie Mae • Freddie Mac • Are not official departments of the U.S. government but enjoy the backing of the federal government • Issue debt to purchase long-term mortgages

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