NEW YORK – When you sit at your kitchen table and write your monthly mortgage check, your signature may be the first stop on a journey that takes your money to the other side of the world.
Chances are, your bank has resold your mortgage and the Chinese government, a teachers’ pension fund in Holland, even one of your own mutual funds may own a slice of it. Thousands of investors could be getting slivers of your check.
How did that happen?
The pooling and reselling of mortgages, known as mortgage securitization, has played an outsized role in this financial crisis. Here are some questions and answers about mortgage securitization and its effects.
Q. What is mortgage securitization? And what are mortgage-backed securities?
A. Mortgages are “securitized” when they are pooled together, sliced into pieces and resold as bonds. A mortgage-backed security is a bond whose payments come from the monthly checks for the underlying mortgages.
The bonds are put together either by government-sponsored entities Fannie Mae and Freddie Mac, which are charged with repurchasing mortgages in an effort to keep homes affordable, or by private financial institutions. Some of the largest players included the ill-fated Countrywide, Bear Stearns and Lehman Brothers.
Here’s a greatly simplified (and hypothetical) mortgage-backed security, as described by Richard J. Rosen, a senior economist and economic adviser at the Chicago Federal Reserve:
An issuer has collected 1,000 mortgages, each worth $100,000, each with a 30-year maturity and a fixed interest rate of 6.5 percent. This $100 million pool of mortgages can back 10,000 bonds, each worth $10,000 and paying interest that’s slightly less than what the homeowners pay – say 6 percent – after the intermediaries, including the packager, take a cut.
Most of the mortgage-backed securities sold over the last five years were far more complicated, with some involving mortgages that were grouped by how risky they were thought to be.
Q. How big is this market?
A. Somewhere around $6.8 trillion, out of $11.3 trillion in mortgages outstanding, according to Guy Cecala, publisher of Inside Mortgage Finance.
The proportion of mortgages that are securitized is much greater than it was a few decades ago. In 1980, mortgage-backed securities accounted for 12 percent of total mortgage debt outstanding. This year, the proportion is closer to 61 percent, according to Cecala.
Q. How did it get so big?
A. Mortgage-backed securities had historically been a fairly safe investment offering a better return than even safer U.S. Treasury debt. With interest rates near historic lows from 2001 to 2004, investors around the world were trying to earn more on their investments. At the time, mortgage-backed securities, which had been heavily promoted abroad by the U.S. government, seemed like a fairly safe option.
As global investors demanded more mortgage-backed securities, banks began looking for more mortgages to buy, repackage and resell. This was one of the reasons lending standards loosened. By the time it became clear that many home loans had gone to people who wouldn’t be able to repay them, the market had grown large enough to shake investors all over the world – from community banks in California to multibillion-dollar banks in Germany.
When that happened, investors refused to buy the securities, and the banks that had been selling them were stuck with them. The plunge in their value has contributed to more than $300 billion in write-downs – or reductions in the value of assets – by global banks and brokerages. Stock in the banks with the largest involvement plummeted; the weakest were bought by competitors at steep discounts and the survivors have been less likely to loan money.
Q. Who owns mortgage-backed securities?
A. As of the middle of 2008, foreign investors were the largest group, owning 20 percent of the outstanding volume of mortgage securities, Cecala said.
“That reflects a real conscious effort by the government to promote that,” he said. “Ginnie Mae, Fannie Mae and Freddie Mac would do road shows around the world.”
The next largest group was Fannie Mae and Freddie Mac, with 16 percent. Commercial banks own another 16 percent.
Q. Who owns my mortgage?
A. That depends on what kind of mortgage you have. If you were a good borrower with a fixed-rate, 30-year mortgage for less than $417,000, the chances are excellent that Fannie Mae or Freddie Mac either owns your mortgage or guarantees it. If you have an adjustable-rate mortgage, it’s likely held by a bank or another financial institution.