paper about MBS

Housing markets in chapter 6 we proposed a new

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Unformatted text preview: housing markets. In Chapter 6 we proposed a new mortgage liquidity facility at the Treasury Department instead. We also proposed that the Fed would pass on its purchases to such a facility shortly after purchase instead of warehousing mortgage assets. Since the facility would be pre-funded with an asset limit, once that limit is reached, the bailout would end. 8.2 The Guarantee Function of the GSEs The second main function of the GSEs, and arguably the most important one, is to guarantee the credit risk in the mortgage loans that are bundled and sold off as mortgage- backed securities to the public. While the GSEs do not own these mortgage loans, they are responsible for all losses that are due to mortgage borrowers’ defaults. Our second main recommendation is that the current guarantee function of the GSEs should be revisited, with the goal of better balancing systemic risk, efficient pricing, and market discipline. The government has not announced any formal plans for the future of the guarantee function of the GSEs. Before any discussion of various proposals, we need to address whether mortgage guarantees -- private or public – are really needed for secondary mortgage markets to function. There are other credit markets, most notably the corporate bond market, which function without such guarantees. What is special about mortgages? There are several features somewhat unique to mortgages. First, while mortgages certainly contain a number of standardized characteristics (such as loan-to-value, income-to-payment, FICO credit score, et cetera), mortgages and therefore pools of mortgages (as found in MBS) are nevertheless fairly opaque and 109 heterogeneous by nature -- more so than corporate debt. Second, while some parts of the corporate debt market could falter, there is usually an alternative source of financing for corporations, such as commercial paper, bank loans, preferred stock, common stock, convertible bonds, and plain vanilla public debt issuance. There is no plan B for the mortgage market. Third, mortgage finance is at the center of economic household activity; without access to mortgage finance in difficult times, the economy would go into a tailspin. Because mortgages are opaque, underlying uncertainty about the credit risk of these underlying mortgages makes MBS less liquid than otherwise similar debt securities. Liquidity is the ability to convert securities immediately into cash, and becomes particularly valuable to investors in times of distress. As the current crisis – and even preceding ones such as the collapse of Long Term Capital Management – showed, the market for MBS without credible guarantees – even safe, so-called AAA-rated MBS – can freeze temporarily or even collapse altogether as the risk of financial firms rises, the investors’ risk appetite wanes, and the demand for cash soars. Investors demand a premium for bearing such illiquidity, and that translates to higher interest rate spreads. To the extent that guarantees enhance liquidity of the secondary higher interest rate spreads....
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housing markets In Chapter 6 we proposed a new mortgage...

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