Secondary Mortgage Markets: Increasing Capital and Improving Housing Affordability

FULL TEXT: Download complete issue (*.pdf, 656 KB) Order a printed copy of the whole text

The success of an emerging secondary mortgage market (SMM) hinges on three factors: the existence of a strong primary mortgage market, stable legal and governmental infrastructures, and the availability of well-trained accounting and legal professionals. SMMs separate mortgage origination and mortgage investment, thereby increasing the number of mortgage investors and available capital in the primary market. This increased capital flow reduces the risk associated with carrying long-term loans, which in turn can reduce the cost of residential mortgages and make homeownership more affordable.

Mortgage Securitization — Lessons for Emerging Markets, a new study prepared for HUD’s Office of Policy Development and Research, argues that in order to develop efficient SMMs, market transparency and predictability must be present across all market elements. With transparency and predictability, it’s possible to attract and maintain a steady stream of capital investment. Primarily intended for an international audience, the report identifies the key participants and elements necessary to create and sustain viable SMMs, looking closely at the United States and presenting case studies of SMMs in Taiwan, Guatemala, and Romania.

Market Components

Reducing the risk of carrying long-term loans can help make homeownership more affordable.

Because a secondary market cannot exist unless the primary market is strong, the first step in developing an SMM is to address any weaknesses in the primary market. In Romania, where the residential mortgage market emerged only within the past few years, this has meant improving economic conditions and making mortgages more affordable. One way to accomplish these goals is to extend loan terms from 10 – 15 years to 20 – 25 years, thereby lowering consumers’ monthly payments. Traditionally, many Asian cultures attach a social stigma to borrowing. In Taiwan, this cultural aversion to carrying consumer debt is a hurdle to increasing residential mortgages; there, extended families are the main source of funds for homeownership. This cultural standard is changing, however, with younger Taiwanese becoming more willing to take out home loans, thus enabling growth in the primary mortgage market.

Loan originators in the primary market will also need to standardize loan products and underwriting criteria. Defining loan terms (loan type, amortization, and payment frequency) and underwriting criteria (minimum downpayments, maximum loan-to-value ratios, and minimum credit standards for borrowers) across the primary market provides secondary market buyers with the necessary information to accurately price mortgage-backed security (MBS) products.

The report observes that for an SMM to attract capital investment, primary lenders and secondary market participants must have open and consistent avenues of communication. In addition, they must standardize the process of bundling and transferring primary-market mortgages to the SMM, so that all participants understand their rights and responsibilities regarding the MBSs’ underlying loans. For example, one important element of transferring a loan is defining which party is responsible for loan servicing. In the United States, originators can retain servicing responsibilities, or another loan servicer can be designated with the approval of the MBS trustee. The party that retains servicing responsibilities maintains data on individual loan performance to inform the MBS trustee of activities in its loan portfolio and, in turn, inform investors.

Countries undertaking SMM development must have sufficient professional and legislative infrastructures to create and maintain SMMs. Governments must address early on what enabling legislation is needed and who will regulate the market, taking care to create a system that achieves consistent results. The trading and pricing of MBSs can be complex. Achieving transparency and predictability requires close interaction among well-informed direct and indirect market participants, including mortgage originators; insurers; regulators; and legal and technical advisors such as auditors, tax accountants, attorneys, and independent valuation providers.

Emerging Markets

The emerging markets examined in the report face several challenges in their efforts to develop or maintain an SMM. However, each country’s efforts are proceeding in the hope of increasing housing affordability and attracting additional international capital. A quick scan of progress achieved to date shows that…

• After four years of reforming its financial and capital markets, Romania issued its first MBS in 2005. The report suggests that the country needs to clarify its legal infrastructure and tax rules for these securities before the SMM can move forward.

• Taiwan spent 10 years studying SMM development and issued its first MBS in 2004. Challenges for Taiwan’s SMM include setting standards for mortgage products and underwriting criteria and developing a mortgage insurance system. Despite these impediments, the Taiwanese SMM is growing, having issued six MBSs in the past three years.

• Guatemala has many of the criteria needed to develop an SMM — an active primary market, a history of securitization, and an openness to international financial institutions. However, it lacks a fully functioning capital market system for trading MBSs. To overcome this hurdle, the United States’ Overseas Private Investment Corporation is working with Guatemala and other small countries to develop a means of selling MBSs in foreign secondary markets.

Building an effective SMM takes time and a coordinated legal, economic, and regulatory infrastructure. Mortgage Securitization — Lessons for Emerging Markets is a helpful reference for developing and sustaining SMMs around the world. The report can be downloaded at no cost at www.huduser.org/publications/hsgfin/mortgsecurity.html.

Planning for Future Natural Disasters Credit: FEMA/Jocelyn Augustino Two articles in the most recent issue of Cityscape (Volume 9, Number 3) focus on preparedness for natural disasters. “Planning, Plans, and People: Professional Expertise, Local Knowledge, and Governmental Action in Post-Hurricane Katrina New Orleans” examines the successes and pitfalls of four recovery plans in New Orleans. “Hurricane Katrina: Environmental Hazards in the Disaster Area” shares post-hurricane lessons learned that can ease public apprehension about the environmental effects of future disasters. These articles are available as free downloads at www.huduser.org/periodicals/cityscape.html. The complete issue of Cityscape is also available in print for a nominal fee by calling HUD USER at 800.245.2691, option 1.