Development of rmbs market in India: Issues and Concerns

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5The US Success Story

The US secondary mortgages market is considered to be the world’s most developed mortgage securitisation market. Due to this reason it has always been an area of interest to people of other countries, to see how it has worked and to learn the lessons from it. This study also incorporates this element besides others and goes to the extent of looking how the advantages of the US secondary mortgages can be replicated in the Indian context.

The US mortgages market consists of primarily three participants besides the mortgagor: the mortgage originators, the secondary market conduits and the investors in the secondary market.
The mortgage originators are commercial banks, thrifts, mortgage banks, and mortgage brokers. The main secondary market conduits are Fannie Mae, Ginnie Mae and Freddie Mae. Some private investment banks also act as conduits in the secondary mortgages market, but to a limited extent. The investors in the secondary mortgages market are the pension funds, the life insurance companies, the commercial banks, the thrifts, and Fannie Mae.
The total outstanding mortgage debt in US was $6.2 trillion at the end of 2003. Moreover, at 2003 end the total outstanding debt of three GSEs was more than USD 2.4 trillion, in comparison to the publicly held debt of USD 4 trillion for the federal government. At the end of Q2 of 2004, the outstanding mortgage related debt was USD 5357.5 billion dollars as compared to treasury (USD 3755.5 billions) and corporate debt of USD 4569.9 billions
The two-third of Americans won their homes and over two-third of the residential mortgages are securitized. The US mortgage value chain is significantly unbundled with different organizations specializing in different parts of the value chain.

5.1Institution framework for the Secondary Mortgages Market

5.1.1Regulatory Framework

The housing and mortgages industry in US is overseen by U.S. Department of Housing and Urban Development (HUD). It also sets goals for government owned Ginnie Mae, and Government Sponsored Enterprises (GSE) like Fannie Mae and Freddie Mac.

The Secretary of HUD is the mission regulator for Fannie Mae and Freddie Mac with oversight authority to ensure that both GSEs comply with the public purposes set forth in their charters. The secretary is charged with the general regulatory authority over GSEs in all areas other than the GSEs financial safety and soundness. The secretary’s authority includes setting and enforcing three affordable housing goals, monitoring compliance with fair lending principles, collecting loan-level data from the GSEs on their loan purchase activities, creating and distributing a public use data base of non-proprietary GSE purchase data, and providing oversight for new program approval.

The financial safety and soundness of GSEs is regulated by an independent office of HUD, the Office of Federal Housing Enterprise Oversight (OFHEO). It regulates both the GSEs for safety and soundness, by ensuring that they are adequately capitalized and operating their businesses in a financially sound manner.

5.1.2Key Organizations in Secondary Mortgages Market

The three agencies form the backbone of the US secondary mortgages market. Their main objectives are:

  • Providing stability to the mortgages market

  • Responding to the changing capital markets

  • Assisting the secondary markets including the support of these markets for affordable housing

  • Promoting access to credit throughout the country by increasing liquidity and improving distribution of investment capital for residential mortgages market
  • Secondary market investor buys mortgages within their guidelines and limits, which are revised from time to time depending upon the market considerations

Fannie Mae

It was established in 1938 to buy Federal Housing Administration (FHA) insured mortgages and to create a secondary market for mortgages. It is the second largest corporation in US in terms of assets. Till 1968 it was owned by the federal government, but since then it has been a privately owned company.
Its main activities are:

  • Pays cash for mortgages bought from lenders in the primary market and keep them in its books

  • Issues Mortgage Backed Securities in exchange of pool of mortgages from lenders

  • Buys MBS from the secondary market

Fannie Mae funds it capital requirements by issuing debt securities like debentures, notes, bonds to the investors. In 2003 it had Senior debt of USD 947.72 billions and Subordinated debt of USD 464.53 billions. The companies main source of earnings are the spread due to yield on mortgages and the cost endured to buy them, and by fees earned for providing guarantees to MBS issues. The guarantees issued by Fannie Mae assures the buyers of MBS that they will receive timely principal and interest payments regardless of what happens to the underlying mortgages.

In 2003 the company had total Mortgage assets of USD 906.53 billions. Out of which MBS accounted for USD 665.95 billions and loans (mortgages) accounted for USD 240.58 billions. In MBS 71.35% of MBS were in “help to maturity category” and 28.65% were in “available for sale” category.

In the present circumstances the company’s role is to provide a steady stream of mortgage funds to lenders across the country and introduction of new technologies that make the process of buying a home quicker, easier, and less expensive.

Ginnie Mae

It was established on September 1, 1968 after being partitioned from Fannie Mae. It is a government corporation within HUD. It is the only agency to offer mortgage-backed securities backed by the full faith and credit of the United States government. It provides guarantees on timely payment of principal and interest on MBS backed by federally insured or guaranteed loans – mainly by Federal Housing Administration (FHA), Department of Veterans Affairs (VA), Rural Housing Service (RHS) and Office of Public and Indian Housing.
It does not buy or sell loans or issue mortgage-backed securities (MBS) and so its balance sheet doesn't use derivatives to hedge or carry long term debt. Due to this its balance sheet size is smaller in comparison to the balance sheet size of Fannie Mae and Freddie Mac. Also Ginnie Mae has got no MBS under “held till maturity” category.

Freddie Mac

It was established in 1970 as a private company. Like Fannie Mae it also purchases residential mortgages and mortgage related securities and issues MBS, but is smaller in size as compared to Fannie Mae. It also issued debt instruments to fund its activities. Freddie Mac is the purchaser of one in six mortgages that is done in US.
As on March 31, 2004 its mortgage assets totaled $635.6 billions, of which a total of USD 60.3 billion was mortgage loans and USD 575.2 billion was MBS. It also had USD 798.9 billion outstanding in guaranteed mortgage backed securities.

5.1.3Support to GSEs from the US Government

The government of US provides support to GSEs through various means. Some of them are listed below:
  • The government provides no direct subsidy

  • Exemption from local and state taxation

  • Exemption from securities registration requirement

  • Line of credit at the US treasury

  • Implicit protection of GSEs debt against default

5.1.4Possible problems with GSEs

  • Availability of fewer funds for business investment

  • Moral hazard problem related to risk taking

  • Incomplete pass-through of subsidies intended for mortgage borrowers

  • Risk shifting to the Federal Deposit Insurance Corporation

  • Risk taking by GSEs could undermine the stability of the financial system because lot of banks depend on them for liquidity

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