Restoring Trust in Mortgage-Backed Securities
May 9, 2012
The mortgage finance market has leaned heavily on government support over the past few years. More than 90 percent of mortgages originated in 2011 were securitized by the government entities Fannie Mae and Freddie Mac. These institutions use taxpayer funds to guarantee investors against default risk, and therefore create an exposure that should be considered unsustainable in the long run, say Marc Joffe and Anthony Randazzo of the Reason Foundation.
Furthermore, the status quo perpetuates many of the policies that contributed to the housing bubble and consequently promotes an unstable mortgage market. In order to avoid another crisis, the government must exit mortgage finance and private capital must shoulder mortgage default risk.
The private sector faces a number of obstacles in performing this transition:
- There remains profound lack of confidence in the models used by credit rating agencies to assess residential mortgage-backed securities (RMBS), as the failure to accurately rate these assets contributed in part to the bursting of the housing bubble.
- Private capital remains wary of the complex legal framework that governs RMBSs.
- Another obstacle is high conforming loan limits that perpetuate market share dominance of Fannie Mae and Freddie Mac, and the growing market share of Ginnie Mae and the Federal Housing Authority.
Nevertheless, policymakers and industry captains alike should recognize the possible consequences of the current situation, and should actively seek to derail current trends. To this end, a number of practices should be considered.
- First, Congress should authorize underwriters to include property-level address data in RMBS disclosures so that investors or independent analytic firms can perform more detailed and accurate risk assessments at lower cost.
- Second, the mortgage-finance industry should create an organization to provide self-regulation against misrepresentation and to enhance liquidity by promoting standardization.
- Third, the industry should encourage common formatting of RMBS collateral data and the inclusion of cashflow-waterfall models with prospectuses to make investor due diligence easier, more competitive and less costly.
- Fourth, greater transparency of the underlying assets of securities should be encouraged, allowing for greater competition and fact-checking between credit rating agencies.
Source: Marc Joffe and Anthony Randazzo, "Restoring Trust in Mortgage-Backed Securities," Reason Foundation, May 3, 2012.
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