Research Finds MBS Key for Fixed-Rate Mortgages

Public credit guarantee MBS in particular have proved key to maintaining access to FRMs when private MBS markets lock up. Image: Fotolia.

U.S. consumers and advocates generally grew fonder of fixed-rate mortgages while criticizing securitization in the wake of the downturn, but recent research suggests mortgage-backed securities advocates are right when they argue that the former is largely inseparable from the latter.

“Our interpretation is that securitization is particularly important for [U.S.] FRMs because of the prepayment and interest rate risk embedded in these loans,” Andreas Fuster and James Vickery, authors of a Federal Reserve Bank study, said in a summary of findings based on LPS Applied Analytics data.

“Lenders are averse to training exposure to the risks associated with FRMs in a portfolio,” they note. “Securitization increases lenders’ willingness to originate FRMs by transferring these risks to a diverse international pool of investors.”

Interestingly, the research also examines “whether public mortgage credit guarantees like those currently provided by [Fannie Mae and Freddie Mac] are necessarily to support FRMs” and find it also would be difficult to maintain stable markets for FRMs during periods of stress with government-related MBS.

It finds that “when private MBS markets are liquid and well-functioning, as in the period before the onset of the financial crisis in mid-2007, private and government-backed securitization perform similarly in terms of supports FRM supply.

“However, public credit guarantees may make securitization less susceptible to market disruptions, thereby improving the stability of FRM supply.”

In another interesting finding when it comes to industry rulemaking is that the study’s results “suggest that financial regulations that discourage or limit securitization (e.g., stringent risk retention rules) may constrain FRM supply, by limiting lenders’ ability to transfer risks associated with these loans.”

But the researchers say they ultimately “do not take a normative stance regarding the desirability of FRMs” but note their findings “do have several implications for mortgage finance policy.”

They also note that their results “are identified using local variation in the likelihood of securitization; it is possible they would not translate closely to a large change in market structure.” But they said, their “cautious overall interpretation, however, is” that their conclusions “are likely robust.”

Some securitization critics have acknowledged a tie between 30-year FRM and MBS and been prepared to offer up alternative models for the U.S. in which there are no FRMs, and the report supports a related point they often make that U.S. reliance on FRM is unusual from a global perspective.

While the U.S. residential mortgage market “is dominated by prepayable 30-year fixed-rate mortgages” they are “a type of home loan that exists in few other countries,” the report affirms.

The fact points to factors that create mixed feelings about the interdependence between U.S. MBS and 30-year FRMs in this country not only when it comes to consumers, but when it comes to the business side of the market as well.

While consumers favor the 30-year mortgage’s traditional prepayable option while criticizing the securitization that supports it, securitization market participants and their advocates often support MBS while noting disadvantages in U.S. FRMs’ prepayability.

“FRMs retained in portfolio pose significant interest rate risk and prepayment risk for mortgage lenders, relative to adjustable-rate mortgages, the main alternative contract type,” the study finds.

So generally businesses in the U.S. mortgage market might be willing to do without securitization, if borrowers were willing to give up prepayable fixed-rate mortgages, but such a tradeoff seems neither likely nor easy to execute.

This suggests 30-year FRMs are likely to continue to be dependent on securitized, guaranteed MBS for the foreseeable future.