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Who Buys Mortgage Backed Securities

The Federal Reserve announced on Tuesday that it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs)--Fannie Mae, Freddie Mac, and the Federal Home Loan Banks--and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Spreads of rates on GSE debt and on GSE-guaranteed mortgages have widened appreciably of late. This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally.

who buys mortgage backed securities

A Mortgage-backed Security (MBS) is a debt security that is collateralized by a mortgage or a collection of mortgages. An MBS is an asset-backed security that is traded on the secondary market, and that enables investors to profit from the mortgage business without the need to directly buy or sell home loans.

When an investor buys a mortgage-backed security, he is essentially lending money to home buyers. In return, the investor gets the rights to the value of the mortgage, including interest and principal payments made by the borrower.

The pass-through mortgage-backed security is the simplest MBS, structured as a trust, so that principal and interests payments are passed through to the investors. It comes with a specific maturity date, but the average life may be less than the stated maturity age.

Collateralized mortgage obligations comprise multiple pools of securities, also known as tranches. Each tranche comes with different maturities and priorities in the receipt of the principal and the interest.

If the bank decides to sell the mortgage to another bank, government institution, or private entity, it will use the proceeds from the sale to make new loans. The institution that buys the mortgage loan pools the mortgage with other mortgages having similar characteristics, such as interest rates and maturities.

Freddie Mac and Fannie Mae both buy large numbers of mortgages to sell to investors. They also guarantee timely payments of principal and interest on these mortgage-backed securities. Even if the original borrowers fail to make timely payments, both institutions still make payments to their investors.

Low-quality mortgage-backed securities were among the factors that led to the financial crisis of 2008. Although the federal government regulated the financial institutions that created MBS, there were no laws to directly govern MBS themselves.

With a steady supply of, and increasing demand for, mortgage-backed securities, Freddie Mac and Fannie Mae aggressively supported the market by issuing more and more MBS. The MBS created were increasingly low-quality, high-risk investments. When mortgage borrowers began to default on their obligations, it led to a domino effect of collapsing MBS that eventually wiped out trillions of dollars from the US economy. The effects of the sub-prime mortgage crisis spread to other countries around the globe.

Mortgage-backed securities typically offer yields that are higher than government bonds. Securities with higher coupons offer the potential for greater returns but carry increased credit and prepayment risk, meaning the realized yield could be lower than initially expected. Investors may receive higher payments compared to the income generated by investment-grade corporate issues. A portion of these payments may represent return of principal due to prepayments.

Credit risk is affected by the number of homeowners or borrowers in the pool of mortgages who default on their loans. Credit risk is considered minimal for mortgages backed by federal agencies or government-sponsored enterprises.

While MBS backed by GNMA carry negligible risk of default, there is some default risk for MBS issued by FHLMC and FNMA and an even higher risk of default for securities not backed by any of these agencies, although pooling mortgages helps mitigate some of that risk. Investors considering mortgage-backed securities, particularly those not backed by one of these entities, should carefully examine the characteristics of the underlying mortgage pool (e.g., terms of the mortgages, underwriting standards, etc.). Credit risk of the issuer itself may also be a factor, depending on the legal structure and entity that retains ownership of the underlying mortgages.

In general, bond prices in the secondary market rise when interest rates fall and vice versa. However, because of prepayment and extension risk, the secondary market price of a mortgage-backed security, particularly a CMO, will sometimes rise less than a typical bond when interest rates decline, but may drop more when interest rates rise. Thus, there may be greater interest rate risk with these securities than with other bonds.

Depending on the issue, the secondary market for MBSs are generally liquid, with active trading by dealers and investors. Characteristics and risks of a particular security, such as the presence or lack of GSE backing, may affect its liquidity relative to other mortgage-backed securities.

CMOs can be less liquid than other mortgage-backed securities due to the unique characteristics of each tranche. Before purchasing a CMO, investors should possess a high level of expertise to understand the implications of tranche-specification. In addition, investors may receive more or less than the original investment upon selling a CMO.

A security is an investment made with the expectation of making a profit through someone else's efforts. In the case of mortgage-backed securities, the investor attempts to profit through the efforts of a mortgage lender.

These securities distribute monthly principal and interest payments due on underlying mortgages to investors. While agency MBS investors are shielded from credit risk by government guarantees, they do face prepayment risk.

What was the policy objective of the Federal Reserve's program to purchase agency mortgage-backed securities?The goal of the program was to provide support to mortgage and housing markets and to foster improved conditions in financial markets more generally.

BackgroundIn response to the emerging financial crisis, and in order to mitigate its implications for the U.S. economy and financial system, the Federal Reserve eased the stance of monetary policy aggressively throughout 2008 by reducing the target for the federal funds rate. By December of 2008, the Federal Open Market Committee (FOMC) had reduced its target federal funds rate to a range of between 0 and 1/4 percent. With the target federal funds rate at the effective lower bound, the FOMC sought to provide additional policy stimulus by expanding the holdings of longer term securities in its portfolio, the System Open Market Account (SOMA), including large-scale purchases of fixed-rate, mortgage-backed securities (MBS) guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae (referred to as "agency MBS"). The purchases were intended to lower longer-term interest rates and contribute to an overall easing of financial conditions.

In response to the global financial crisis, the Fed began purchasing Treasury securities and mortgage-backed securities in 2009. There were three rounds of purchases dubbed QE1, QE2, and QE3. The first two were for pre-announced totals. The third, launched in September 2012, was open-ended; the Fed said it would keep buying bonds until labor market conditions improved.

Just like any market for securities, the value of mortgages on the secondary market depends on their risk and potential return. Higher-risk loans must offer higher returns, which is one of the reasons that people with lower credit scores pay higher interest rates.

After making a loan, a bank often sells it in the secondary mortgage market, though the bank may retain the servicing rights. Many loans are sold to the government-sponsored enterprises Fannie Mae and Freddie Mac or other aggregators, which can repackage the loans as mortgage-backed securities, or MBS, or hold them on their own books and collect the interest from borrowers.

The Justice Department, along with federal partners, announced today a $7.2 billion settlement with Deutsche Bank resolving federal civil claims that Deutsche Bank misled investors in the packaging, securitization, marketing, sale and issuance of residential mortgage-backed securities (RMBS) between 2006 and 2007. This $7.2 billion agreement represents the single largest RMBS resolution for the conduct of a single entity. The settlement requires Deutsche Bank to pay a $3.1 billion civil penalty under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). Under the settlement, Deutsche Bank will also provide $4.1 billion in relief to underwater homeowners, distressed borrowers and affected communities.

We examine the quantitative impact of the Federal Reserve's mortgage-backed securities (MBS) purchase program. We focus on how much of the recent decline in mortgage interest rate spreads can be attributed to these purchases. The question is more difficult than frequently perceived because of simultaneous changes in prepayment and default risks. When we control for these risks, we find evidence of statistically insignificant or small effects of the program. For specifications where the existence or announcement of the program appears to have lowered spreads, we find no separate effect of the size of the stock of MBS purchased by the Fed.

This part describes the requirements associated with the two primary ways lenders transact business with Fannie Mae: selling whole loans for cash and pooling loans into Fannie Mae mortgage-backed securities (MBS), which includes Uniform Mortgage-Backed Securities (UMBS). It includes the following subparts: General Information on Execution Options and Loan Delivery, Whole Loan Transactions, Mortgage-Backed Securities (MBS).

Fannie Mae and Freddie Mac are companies that were chartered by the Congress four decades ago to provide a stable source of funding for residential mortgages across the country, including loans to finance housing for low- and moderate-income families. To carry out that mission, they purchase mortgages that meet certain standards from banks and other originators, pool those loans into mortgage-backed securities (MBSs) that they guarantee against losses from defaults on the underlying mortgages, and sell the securities to investors. They also buy mortgages and MBSs and hold them in their portfolios. 041b061a72


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