The amount of mortgage-backed securities placed into the secondary markets by Fannie Mae and Freddie Mac is declining as part of the mandate to reduce the size of the government-sponsored enterprises. The dwindling supply will push investors into other areas naturally and a space that may be a good replacement is the short-term GSE-collateralized mortgage obligation space, according to Amherst Securities. CMOs are an earlier, simpler version of residential and commercial mortgage-backed securities. In these bonds, more properties are typically used than necessary. As defaults rise, performing properties replace nonperforming. This type of credit enhancement, known as overcollateralization, is more common in CMOs than RMBS. Amherst notes that Fannie and Freddie portfolios contracted from $1.53 trillion at the end of 2009, to $1.49 trillion at the end of 2010, to $1.38 tillion in September 2011. It’s a trend they expect to continue. However, other market conditions are leading to fewer short Treasurys being issued as well. CMOs are based on mortgages originated by loans and thrifts, and the market is growing. “The increase in agency CMO holdings by U.S. banks and thrifts at $252 billion is more than the total growth of mortgage holdings of $194 billion,” Amherst said in a note to investors. “And this amount must increase more, as short CMOs will benefit from the shortage of other products.” Write to Jacob Gaffney. Follow him on Twitter @jacobgaffney.