The Gap Between Government and Private Securitizaton

The Gap Between Government and Private Securitizaton

Tom Toles' piece in the Washington Post today (<http://www.washingtonpost.com/wp-dyn/content/article/2011/02/12/AR2011021203363.html>)  neglects any mention of the gap between Public and Private Securization, as defined by the GSEs and FHA role in the secondary market vs. the private market.  The government dominates the secondary market today with over 90% of all securitization.  The gap between the two is what needs to be fixed.  During the Housing Crisis of 2007, the GSEs generated less than half  (HMDA, 2007, Loans Sold by Purchaser Type) of all  loans sold.  One of the differences was the standards for loans originated by the GSEs and private market. The securization function of buying whole subprime loans versus subprime securities also offered different results.  Although the GSEs leverage ratios were too high, they insure around half of all loans, they represent a much smaller portion of delinquent loans, and enable the market to provide lower interest rates with their funding advantage.  The creation of a government entity such as the FDIC acts to insure bank deposits would go a long way and play an important role in bridging the gap between the public and private market.

The gap between the public and private market could be bridged over a time horizon of 7-10 years, with the ultimate goal of reducing government involvement to less 50% of all insurance and new production of home purchase and refinance loans. The Consumer Financial Protection Bureau created standards for qualified mortgages to be insured by the public and private market.  Deviation from these standards would invite cream-skimming and cherry picking by private insurers (Calem, et. al), whose risks could become opaque over time, positively correlated with the rate of change in house prices. The trade off between government and private securitization is the insurance risk, counterparty credit risk, transparency, and funding costs involved in a given transaction.

Currently the funding costs are determined in bond auctions by FHLMC and FNMA securities. Liquidity considerations would need to be considered, given the function represented in the price.

http://www.washingtonpost.com/wp-dyn/content/article/2011/02/12/AR2011021203363.html

Information Asymmetries exists between counterparties in the securitization of mortgages.   These risks could be mitigated with additional transparency and information provided in the TBA market.  Complete transparency could be established in a bond trading over public exchanges providing details of a security. For example, a generic ticker symbol could represent all 30-year fixed rate mortgages with FICOs above 700 originated by entity Z in the state of NY.

All mortgages meeting this criteria would be packaged into this bond and traded in the open market, just like any other stock.  The securities would be grouped with similar loan amounts and other characteristics as deemed necessary and serve as a future proxy for the credit characteristics of new househoulds or U.S. consumers in a specific geographic region (U.S. national, Census region, State).

Currently the funding costs of mortgages are determined in bond auctions by FHLMC and FNMA securities. Liquidity considerations would need to be considered, given the function represented in the price.  The transition to an entity that combines the FHLMC and GSE securities to one entity could take a significant period of time given the infrastructure, technology and resources that enable them to insure 30 year fixed rate mortgages at significant funding advantages in the bond market.  The price passes through to consumers when they obtain a mortgage because of the governments ability to tap bond markets and baseline funding cost advantages.  


Throughout history, governments have always stepped in when markets (and other governments) fail.  The investment in U.S. military resources is the ultimate provider of insurance in the event of a crisis (Ferguson, N., Ascent of Money: Financial History of the World) .