The Mortgage-Backed Securities Market: Size And Significance

Mortgage-backed securities (MBS) are investments like bonds that represent claims on the money generated by pools of mortgage loans. The MBS market has evolved significantly since the 2007-2008 financial crisis, which was largely triggered by the collapse of the subprime mortgage market. Today, the MBS market has more than $11 trillion in outstanding securities and nearly $300 billion in average daily trading volume in the US alone.

The MBS market's evolution since the 2007-2008 financial crisis

The 2007-2008 financial crisis was largely triggered by the collapse of the subprime mortgage market and the complex web of mortgage-backed securities (MBS) and related derivatives. The MBS market has since evolved significantly, with new regulations and increased scrutiny from investors and policymakers.

In the lead-up to the crisis, the total amount of MBS issued almost tripled between 1996 and 2007, to $7.3 trillion. The share of subprime mortgages that were securitised and passed to third-party investors via MBS increased from 54% in 2001 to 75% in 2006. As housing prices peaked in 2006, subprime borrowers started to default on their loans. This led to a decline in housing prices and major global financial institutions that had invested heavily in MBS reported significant losses.

The crisis led to a severe economic recession, with millions losing their jobs and many businesses going bankrupt. The US government intervened with measures such as the Troubled Asset Relief Program (TARP) and the American Recovery and Reinvestment Act (ARRA) to stabilise the financial system.

As a result of the crisis, the MBS market has seen increased regulation and scrutiny. Today, most MBS have the backing of the US government, and to be sold on the market, an MBS must be issued by a government-sponsored enterprise (GSE) or a private financial company. The MBS must also have received one of the top two ratings from an accredited credit rating agency.

Despite the evolution of the MBS market since the financial crisis, there are still concerns about the potential risks associated with these securities. As investments in MBS steadily grow, there is a worry that the next recession could trigger waves of mortgage defaults that could again impact the global economy.

MBS market's current size and trading volume

The MBS market has evolved significantly since the 2007-2008 financial crisis, which was largely triggered by the collapse of the subprime mortgage market and the complex web of MBS and related derivatives. Today, the MBS market remains a major part of the global financial system, with new regulations and increased scrutiny from investors and policymakers. By total value, over three in five mortgages in the US are repackaged as MBS.

In the US, the MBS market has more than $11 trillion in outstanding securities and almost $300 billion in average daily trading volume. Mortgage-backed securities (MBS) are investments like bonds. Each MBS is a share in a bundle of home loans and other real estate debt bought from the banks or government entities that issued them. Investors in mortgage-backed securities receive periodic payments like bond coupon payments.

MBS are asset-backed securities formed by pooling together mortgages. The investor who buys an MBS is essentially lending money to homebuyers. An MBS can be bought and sold through a broker. The minimum investment varies between issuers. Most MBS in the 2020s have the backing of the US government; these are called agency MBS. To be sold on the markets today, an MBS must be issued by a GSE or a private financial company, and the MBS must have received one of the top two ratings from an accredited credit rating agency.

Non-agency MBS, on the other hand, are issued by private financial institutions and are not guaranteed. Instead, securities are grouped by seniority and sold to investors with different risk appetites. Agency MBS are issued by government-sponsored enterprises (GSEs) like Fannie Mae, Freddie Mac, and Ginnie Mae and are considered to be the highest credit, given government backing.

MBS market's role in the global financial system

The MBS market has evolved significantly since the 2007-2008 financial crisis, which was largely triggered by the collapse of the subprime mortgage market and the complex web of MBS and related derivatives. Today, the MBS market remains a major part of the global financial system, with new regulations and increased scrutiny from investors and policymakers.

Mortgage-backed securities (MBS) are investments like bonds. Each MBS is a share in a bundle of home loans and other real estate debt bought from the banks or government entities that issued them. Investors in mortgage-backed securities receive periodic payments like bond coupon payments. The investor who buys an MBS is essentially lending money to homebuyers. An MBS can be bought and sold through a broker.

MBS are asset-backed securities formed by pooling together mortgages. To be sold on the markets today, an MBS must be issued by a GSE or a private financial company, and the MBS must have received one of the top two ratings from an accredited credit rating agency. Agency MBS are issued by government-sponsored enterprises (GSEs) like Fannie Mae, Freddie Mac, and Ginnie Mae, and are considered to be of the highest credit, given government backing. Non-agency MBS are issued by private entities and carry higher risk and potentially higher yields since they are not government-guaranteed.

MBS allow for the efficient allocation of capital and assets in a financial economy, which is the most fundamental function of financial markets. By allowing a free market for the flow of capital, financial obligations, and money, the financial markets make the global economy run more smoothly while allowing investors to participate in capital gains over time.

MBS market's risks and rewards for investors

The MBS market has evolved since the 2007-2008 financial crisis, which was triggered by the collapse of the subprime mortgage market and the complex web of MBS and derivatives. Today, it remains a major part of the global financial system, with increased scrutiny and new regulations.

Risks

The 2007-2008 financial crisis highlighted the risks of investing in MBS. When housing prices peaked in 2006, subprime borrowers started to default on their loans, and the rapid increase in home prices encouraged banks to lower their lending standards. This resulted in a decline in the quality of MBS and the subsequent recession.

MBS are only as sound as the mortgages that back them, and while they are generally considered safer today due to increased regulation, no investment is risk-free. Investors should be aware of the potential risks and review the applicable disclosure documents. For example, MBS issued by private financial institutions (non-agency MBS) are not government-guaranteed and carry higher risk.

Rewards

MBS provide investors with high-quality assets and attractive yields that can fit various portfolio needs and investment strategies. They offer reliable returns and provide liquidity to the real estate market. Investors receive periodic payments, similar to bond coupon payments, creating a consistent cash flow. The pooling of mortgages means there is less investment risk if someone defaults on their mortgage.

Additionally, MBS backed by the US government (agency MBS) are considered to be of the highest credit. These securities are given a 20% risk-based weighting under Basel accounting rules, which determine capital reserve requirements for banking entities.

Historical context of the MBS market

The MBS market has a long and complex history, with early examples of mortgage-backed securities in the United States dating back to the 18th and 19th centuries. These included slave mortgage bonds and farm railroad mortgage bonds, which may have contributed to financial panics. In 1933, the Glass-Steagall Act was introduced, providing safeguards against possible corruption with investment securities like MBSs. This legislation separated commercial banking from investment banking and made it illegal for a banking institution to both sponsor debts and design investment vehicles.

The first mortgage-backed securities for the retail housing market were introduced by Ginnie Mae in 1970, with the first private MBS introduced by the Bank of America in 1977. The MBS market played a central role in the 2007-2008 financial crisis, triggered by the collapse of the subprime mortgage market and the complex web of MBS and related derivatives. The rapid increase in home prices and growing demand for MBS led to banks lowering their lending standards, resulting in a wave of subprime MBSs. The financial crisis wiped out trillions of dollars in wealth and brought down financial institutions such as Lehman Brothers.

In the aftermath of the crisis, the MBS market has evolved significantly, with new regulations and increased scrutiny from investors and policymakers. By 2012, the market for high-quality MBSs had recovered and was profitable for US banks. Most MBSs in the 2020s are backed by the US government and are known as agency MBSs. To be sold on the market, an MBS must be issued by a GSE or a private financial company and receive a top rating from an accredited credit rating agency.

The MBS market remains a major part of the global financial system, with over three in five mortgages in the US repackaged as MBSs. However, there are concerns that the increasing investments in MBSs could lead to another recession and waves of mortgage defaults, impacting the world economy.

Frequently asked questions