The cost as generally argued is that this originate

Info icon This preview shows pages 91–93. Sign up to view the full content.

The cost, as generally argued, is that this originate-to-hold model renders mortgages illiquid and limits mortgage funding to the supply of deposits and other liabilities that are issued by banks and other depository institutions. Also, if the depository institutions originate and hold fixed-rate mortgages, they are likely to be plagued by the interest-rate risk that engulfed the U.S. savings and loan industry three decades ago. The second type is the “new model of banking,” where loans are no longer held on banks’ balance sheets, but are originated to distribute in the form of mortgage-backed securities (MBS). Figure 7-1 shows that, as of 2005/06, the U.S. had the largest securitization share (higher than 50% of all originations), while no other country exceeded 25%. Only Australia and Canada have sizeable MBS markets. The new model of banking became popular as a way of providing liquidity to mortgage markets, but it has always been questioned on incentive grounds: that the “originate-to-distribute” model implies that original mortgage lenders do not have enough “skin in the game” to originate well. More recently, as a result of the financial crisis, researchers have added to the chorus of criticisms by arguing that this new model is more fragile than traditional banking and more subject to regulatory arbitrage (i.e., exploiting loopholes in capital requirements between different regulatory regimes). 47 The third major form of mortgage finance is the “mortgage or covered bond,” popular in Continental Europe, especially in Denmark, Germany, France, and Spain. Covered bonds are issued by banks and share many features with MBS, but also differ in important ways. Most
Image of page 91

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

90 importantly, investors in covered bonds have a general claim on the issuing bank; but in the event that the issuing bank defaults, the investor can claim the underlying mortgage collateral. (This structure is similar to the structure of “repo” transactions and advances from the Federal Home Loan Bank System to its members.) This structure provides two layers of protection for the covered bond investor: the bank’s equity, and the housing collateral. The covered bond model has another advantage relative to the MBS model: When a Danish mortgage bank grants a mortgage, it is obliged to sell an equivalent bond with a maturity and cash flow that matches those of the underlying loan almost perfectly. When the price of that bond falls, the homeowner can purchase that bond to partially pay off her mortgage. This mechanism prevents the kind of price drops in the securitization market that the U.S. has experienced. As such, the covered bond markets seem to offer a liquidity benefit attributed to securitization but also to contain the moral hazard in lending (due to full recourse to the issuing bank’s balance sheet).
Image of page 92
Image of page 93
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern