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ch09(1) - CHAPTER 9 MORTGAGE MARKETS CHAPTER OBJECTIVES 1 2...

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CHAPTER 9 MORTGAGE MARKETS CHAPTER OBJECTIVES 1. To describe the various types of mortgages and mortgage-backed securities available in the mortgage markets. 2. To describe the development of the secondary mortgage markets with the help of the federal government; to discuss how the mortgage markets have evolved over time. 3. To explain why many new forms of mortgages were developed and how they differ from conventional mortgages – both in contractual terms and in terms of who bears the risk for future price and interest rate fluctuations. CHANGES FROM THE LAST EDITION 1. Tables and statistics have been updated. 2. Some sections have undergone minor revisions. 3. A new People & Events box, titled “Option ARMs: Useful Tool or Ticking Timebomb?”, has been added CHAPTER KEY POINTS 1. Mortgage markets are the largest debt markets in the U.S. Mortgages differ from other capital market instruments because (a) real estate is always pledged as collateral, (b) they are not standardized as to their amount, (c) their issuers typically are small, relatively unknown financial units, (d) their secondary markets are relatively limited, and (e) they are greatly affected by many legal restrictions pertaining to their origination and contractual nature. 2. Commercial banks, mortgage pools, thrift institutions, and other financial institutions (including life insurance companies, pension funds, and finance companies), and various government agencies are the major holders of mortgage debt obligations. See Exhibit 9.8. 3. The federal government has played a major role in the evolution of the mortgage markets. (a) First FHA and then VA insurance made it possible for mortgages to be traded in secondary markets, thereby allowing mortgage bankers to thrive and causing private mortgage insurance to be developed as well. 1
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(b) FNMA and FHLMC purchase insured mortgages in the secondary mortgage markets. This has further spurred the development of secondary mortgage markets and related mortgage servicing firms (such as mortgage bankers). (c) FHLMC pools mortgages and sells securities that "pass through" all principal and interest payments to holders, while GNMA facilitates this process with its guarantees. In addition, FHLMC and FNMA issue mortgage-backed bonds. This allows standardized debt instruments to be issued that can compete effectively for funds in the capital markets. Thus, these developments, too, have sparked private sector duplication – which has generated a further increase in the ability of mortgage issuers to compete for funds with issuers of conventional capital market securities. (d) Recent developments like the collateralized mortgage obligation (CMO) and the REMIC have increased the attractiveness of the MBS relative to mortgage loans by reducing pre- payment risk or default risk.
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