Maintaining the current Fannie Mae and Freddie Mac- backed mortgage finance system may not be necessary for fixed-rate mortgages to remain widely available at competitive rates, as long as private securitization markets are liquid, the Federal Reserve Bank of New York said.
Fed analysts Andreas Fuster and James Vickery posted in the securitization and the fixed-rate mortgage report how "supply-side factors influence equilibrium mortgage choice," particularly the role securitization plays in supporting the high share of FRMs in the market.
Based on the results, shares of FRMs are 20 to 30 percentage points higher when lenders are able to easily securitize newly originated mortgages, proving liquidity of securitization markets is a key driver of the availability as well as popularity of fixed-rate mortgages.
Notably, liquidity in the newly issued non-agency mortgage-backed securitization market is low, but is showing improvement.
This is reflected in a small number of recent jumbo MBS deals sponsored by Redwood Trust (RWT), which is set to embark on its first private-label residential-mortgage backed securitization deal of the new year — arranged with Barclays Jan. 15.
Click on the graphs to view securitization activity for jumbo versus non-jumbo.
"Prior to the financial crisis, our results suggest that the FRM share was at most modestly lower amongst jumbo loans ineligible for securitization by Fannie and Freddie, once we control carefully for differences in borrower characteristics between these two submarkets," the Fed noted.
Private MBS markets are likely to be subject to more volatility in liquidity than government-backed markets, which will lead to relatively lower FRM supply in periods when MBS liquidity freezes.
One reason identified in the report as to why private markets might be unable to provide 30-year FRMs at competitive rates for the whole market compared to just the jumbo market is that an elimination of Fannie Mae and Freddie Mac – or significant activity shrinkage in the GSEs activities – could reduce market liquidity of the to-be-announced MBS market.
"This market is used to trade agency MBS, but confers benefits to nonagency originators and investors also," the analysts noted.
In comparison, there is also a possibility that some kind of TBA-like market structure could emerge naturally from a private market in response to wind-down of the GSEs.
Thus, a shift toward a larger, private nonagency MBS market could further increase the liquidity of MBS backed by non-conforming FRMs, providing a positive effect on the supply.
Financial regulations that discourage or limit securitization – stringent risk retention rules – could also constrain FRM supply by limiting lender ability to transfer risks associated with the loans.
"Over 2004 to mid-2007, private securitization provided a close substitute for the government-backed agency MBS market as a means of diversifying the prepayment and interest rate risk associated with FRMs. This enabled lenders to offer long-term prepayable FRMs to jumbo borrowers to the same extent that those loans were available in the conforming segment," the Fed said.