Squeezed homeowners and lenders facing record numbers of defaults aren’t the only ones affected by the mortgage crisis. Countless institutional and individual investors are also experiencing its effects, and it’s reverberating throughout financial markets around the world.
At one time, mortgage lenders kept their loans on their balance sheets until they were paid off. But, in 1938, Congress created the Federal National Mortgage Association — now known as Fannie Mae — to create a secondary market for mortgages to create greater liquidity and increase the flow of capital to homeowners.
Fannie and Freddie
Today, quasi-government agencies, including Fannie Mae and Freddie Mac, and the government agency Ginnie Mae facilitate the bundling of loans into mortgage-backed securities (MBS) to sell to institutional investors. Lenders use the proceeds from these sales to finance new mortgages.
The government sets limits on the size and quality of the mortgages these agencies can purchase. Those that qualify — generally prime loans of under $417,000 made to borrowers whose total debt meets agency standards — are called conforming loans. (That limit has been temporarily increased through December 2008 to help make credit more affordable for qualifying borrowers.)
Investment bank securitization
More recently, investment banks began competing with the agencies in the securitization of mortgages. According to Inside Mortgage Finance, from 2003 to 2006, the agencies’ share of mortgage-backed securities (MBS) issuance fell from 76% to 43%. On the other hand, Wall Street’s share of the secondary mortgage market climbed from 24% to 57% during the same period.
The rapid proliferation of so-called private label issues went hand-in-hand with an equally profound change in mortgage underwriting. Fannie Mae and Freddie Mac purchase and securitize loans they acquire based on guidelines which do not allow for the purchase of many subprime loans, or loans with balances above the conforming loan limit. Private label issuance was an outlet to the secondary market for many subprime and other non-conforming loans.
