Discussion Topic |
|
This thread has been locked |
| Messages 1 - 9 of total 9 in this topic |
TradIsGood
Chalkless climber
the Gunks end of the country
|
|
|
Topic Author's Original Post - Sep 30, 2008 - 06:38pm PT
|
In part I, I discussed briefly the development over time in the market for hogs.
That markets and industries mature is widely studied in the business academic circles.
Let's now trace the mortgage market a bit. After all, today we take for granted that home ownership comes only with 30 year (or 15 year) mortgages. (New cars are mostly financed as well - though financing the purchase of a depreciating asset is not as sound as doing so with one expected to rise in value.)
It was not always the case. Just like the farmer, homes used to be built by the owner, or even, for example, by communities (think Pennsylvania Dutch, or Habitat for Humanity). In the case of HFH, though the property was built by the community, the new owner purchases it by selling a note (mortgage) to a lender.
By the 1920's a market had developed to finance home construction and purchasing.
http://research.stlouisfed.org/publications/review/08/05/Wheelock.pdf
The rapid increases in building activity, house prices, and mortgage debt during the 1920s
are characteristics shared with the recent U.S.
housing boom. The 1920s witnessed an increase
in loan-to-value ratios and frequent use of high
interest rate secondary loans, which is also reminiscent
of the recent experience (Doan, 1997, p. 35;
Dovenmuehle, 1965, p. 2). Further, according to
some commentators, lending standards in the
1920s were unusually lax (Saulnier, 1956, p. 10).
Thus, on the eve of the Great Depression, many
homeowners were not well positioned to withstand
the substantial decline in income or house
prices that would occur over the next three years.
What we are seeing today - at the "consumer" level has occurred before. The paper cited discusses governmental "bailout" activities as a result of the depression.
But there are vast differences between housing finance in the 1920s to 1960s and today.
The 1970s brought a number of GSEs into the picture in an important way. The Federal Housing Agency (FHA), Farmer's Home Agency (FmHa), Veteran's Administration (VA), and others developed standards for housing, uniform underwriting standards
(standards by which credit-worthiness is determined).
The Government National Mortgage Agency (GNMA), backed by the full faith and credit of the Treasury was created. Home ownership is a part of public policy. This agency made it possible for lenders to package mortgages into pools of $1MM or more face value and sell a security backed by those loans,
which were collaterallized by homes meeting uniform standard and mortgages with uniform underwriting. This was a tremendously successful program. A service collected payments and guaranteed to make timely payment of principal and interest to the owner(s) of the securities, regardless of whether the mortgagor (home owner) actually made the payment on time.
For this service, he was entitled to retain 0.44% (annualized) of the principal outstanding. GNMA collected 0.06% for guaranteeing to make the required payments in the event that the servicer defaulted on his obligation. GNMA also arranged to publish the "current balances" so that investors, such as pension funds, and even individuals could own a fractional share of these securities and know what they would get paid.
Investment banks purchased the securities and resold them. They made markets in the securities so that you could get out of the investment with no "prepayment penalty". They would just purchase
and resell to a new investor, just like the security was a stock.
This might not seem to important, but just like the case of the hog market, this offered tremendous advantages to all of its participants. Investors got securities that were as safe as Treasuries, but generally yield about a full percentage point more. Investors also did not have to go visit each home-owner, interview him, appraise his property, etc.
The borrower had a wider array of borrowing opportunities, because his mortgage (FHA/VA) could be bought by any number of lenders who were competing with each other. It is generally believed that as a result, he got a fraction of a percent lower rate than he otherwise would have gotten.
And yes, it introduced a whole industry of specialists. Appraisers, servicing firms, mortgage bankers who were not as heavily capitalized as a savings bank or commercial bank to buy the mortgage, swap it for a security, sell it and repay the loans. Initially most of them made there money by servicing the mortgage. But, in time, some firms specialized in just doing that.
Insurers often would offer life or mortgage insurance to home-owners.
|
|
Karl Baba
Trad climber
Yosemite, Ca
|
|
|
Sep 30, 2008 - 07:30pm PT
|
Dude, I'm as guilty as the next person for off topic spraying but, with compassion for the climbers out there, does this thread really need a Part 2 after only 10 posts on the other thread.
Let's consolidate the OT stuff for the sanity of all in this political season
Post your palin rant after somebody elses, you obama rant on another obama thread and part 2 in the part 1 thread.
Peace
Karl
Are you going to post a part 3 with the additional level of derivative and securities packaged in collections of other securities (making these securities almost impossible to value) Otherwise, what's the problem knowing the value of a package of mortgages that are or aren't being paid?
|
|
jstan
climber
|
|
|
Sep 30, 2008 - 07:43pm PT
|
Don't see our favourite VP in there anywhere but nice show TIG.
Seems to me the involvement of the government, besides the deep pockets aspect, promised the investor there was some standard for evaluating the securities.
That standard is what we lost because the government no longer did its job.
Now I am going to spray.
Just like when the government stopped doing its job when warnings of attacks landed on the desk in the oval office.
An unbiased observer might choose to suggest the personal wealth of all the people who stopped doing their jobs should be legally attached to make the rest of us whole.
|
|
TradIsGood
Chalkless climber
the Gunks end of the country
|
|
|
Topic Author's Reply - Sep 30, 2008 - 08:31pm PT
|
Karl, yes, there are probably a number of other parts. They are not yet written...
The advantage of splitting is you don't have to carve off the fat to get to the meat.
Now there is one other really important difference that altered the landscape in the 1970s.
Computers became cheap enough for banks, mortgage bankers, investment banks. On top of that there was a ready supply of programmers to make them do what was necessary.
GNMA sent a tape out monthly with the mortgage factors. Trying to distribute via books to the number of participants would have been hopeless.
jstan, don't jump the gun here. We are still in the 70's, and we are not even done with them, strictly. There are no real problems with this market.
It has become the second biggest fixed income market in the world by the end of the decade, second only to US Treasuries. Yes, it was even bigger than Federal agency trading and way bigger than corporates.
Money that is available to lend for 10-30 years is reaching borrowers who need it. That is a good thing. We have a crisis a bit out on the horizon, but it could have been much worse had this market not established itself.
|
|
jstan
climber
|
|
|
Sep 30, 2008 - 08:33pm PT
|
Wes:
After one glass of wine I should not speculate like this.
You know that a treasury bill can be stripped into a "zero' and its interest payments, the two being entirely separate securities. I can imagine the same can happen to a package of mortgages. You can buy the zero at $5 and get $10 back in 30 years. Or you can buy the stripped security and get the interest payments. It is all just a present value calculation.
After Facelift, work is such a pain.
|
|
TradIsGood
Chalkless climber
the Gunks end of the country
|
|
|
Topic Author's Reply - Sep 30, 2008 - 08:44pm PT
|
Wes, natural questions and good ones. To be honest I can't recall whether GNMA took ownership of the mortgages, but they issued the security, and the ownership of the mortgages was not transferable from that point. The documentation had to be stored securely so that in any events of default on the collateral, the servicer had the ability to enforce the mortgage terms.
The security could be divided into pieces as small as $25,000 original face value. Since each pool was different, the investment characteristics were numerically different. To some extent they were geographically different as well. They were traded primarily to institutional investors such as pension funds and insurance companies who needed investments that had long term.
No. It is not about getting rich - at least no more than it would be for Amazon to sell books cheaper than retail, but do so in volume. The publisher ends up better off by selling in higher volume and eating fewer returns. The reader gets lower price. And the middle man - Amazon - gets a cut. If you do it in enough size, and do it efficiently with a small number of people, you can make money.
Keep in mind, however, that building a large inventory and making market bets could achieve very large gains or losses. Both happened fairly often.
|
|
TradIsGood
Chalkless climber
the Gunks end of the country
|
|
|
Topic Author's Reply - Sep 30, 2008 - 08:45pm PT
|
jstan, your first statement was spot on!
Treasury Bills can't be stripped. They have no coupons!
:-)
(But the process you describe does work for notes and bonds). But only for Treasuries. And they have a serious wrinkle - it does not work if the issue is callable, or could default.
|
|
TradIsGood
Chalkless climber
the Gunks end of the country
|
|
|
Topic Author's Reply - Sep 30, 2008 - 09:14pm PT
|
Wes, you are asking a technical question. I do not have at my fingertips the answer. But GNMA was the guarantor of the security.
And no investor ever suffered a loss from GNMA investment. Wikipedia has some generally good info and links, though I think there are some minor flaws. Perhaps the lender retained ownership of the mortgages. But I do know that the servicing was a "saleable commodity".
So, is Paulson asking for $700B in order to back the securities? No. He wants the ability to buy securities that are related to mortgages - the ones that have caused the problem.
Is that because the mortgages are no longer valuable since enforcing the mortgage terms would essentially leave the lenders with a stack of houses and/or a good portion of the American public homeless?
Keep in mind, the right to pick up your garbage is valuable. Waste Management is a multi-billion corporation that does just that.
The mortgage products have value - but not what they were originally deemed to be worth!
Watch succeeding chapters for more of that story.
|
|
TradIsGood
Chalkless climber
the Gunks end of the country
|
|
|
Topic Author's Reply - Sep 30, 2008 - 09:49pm PT
|
Who currently holds the securities that are causing problems and why don't they want them?
How would the situation improve from "US" buying the securities that nobody else wants?
Wouldn't that stick "US" with a bunch of crap?
Good questions. Investment banks have some of them. Others likely do as well. I am not privy to the kind of info that Paulson and Bernanke are.
The question before "How?" is "Would?" It is not clear to me that the assumption "that nobody else wants" is true. Somebody always will buy stuff at the right price.
A more important question, getting back to "Would?" is whether anybody can (or be willing to) sell at a fair market price.
At a fair market price, crap becomes manure! :-)
|
|
| Messages 1 - 9 of total 9 in this topic |
|
SuperTopo on the Web
|
Let us know!