Secondary Mortgage Market and Its Economic Impact
Why Your Bank Sells Your Mortgage and How That Helps You
The proceeds give the banks new funds to offer more mortgages. Before the secondary market was established, only larger banks had the deep pockets to tie up funds for the life of the loan, commonly for 15 to 30 years. As a result, potential homebuyers had a more difficult time finding mortgage lenders. Since there was less competition between lenders, they could charge higher interest rates.
The 1968 Charter Act solved this problem by creating Fannie Mae and Freddie Mac two years later. These government-sponsored enterprises buy bank mortgages and resold them to other investors. The loans aren't resold individually. Instead, they are bundled into mortgage-backed securities. Their value is secured, or backed, by the value of an underlying bundle of mortgages.
Before the subprime mortgage crisis, the two owned or guaranteed 40 percent of all U.S. mortgages. As Lehman Brothers, Bear Stearns, and other banks were capsized by mortgage-backed securities and other derivatives during the 2008 financial crisis, private banks exited the mortgage market en masse. As a result, Fannie and Freddie became responsible for almost 100 percent, basically holding together the entire housing industry. This was how Fannie Mae and Freddie Mac were implicated in the subprime mortgage crisis.
In 2103, banks began returning to the secondary market. In 2014, they were still holding onto 27 percent of mortgages instead of selling them onto the secondary market. There were three reasons for this:
- Fannie and Freddie raised their guarantee fees from 0.2 percent of the loan amount to 0.5 percent. As a result, many banks found it was cheaper to hold onto the safest loans.
- Banks made more "jumbo" loans, which exceeded Fannie and Freddie's loan limits. These debts are uninsurable by them. The percentage rose from 14 percent of all originations in 2013 to 19 percent in 2014.
- Banks are made fewer loans. They granted them to only the most credit-worthy customers. The total dollar amount of residential mortgages fell 2.7 percent between 2012 and 2014. During that same time period, their total assets grew 7.6 percent.
Other Secondary Markets
There are also secondary markets in other kinds of debt, as well as stocks. Finance companies bundle and resell auto loans, credit card debt, and corporate debt. Stocks are sold on two very famous secondary markets, the New York Stock Exchange and the NASDAQ. The primary market for stocks, called the initial public offering, involves a company’s first time to offer part ownership to the public through shares of stocks.
Most important is the secondary market for U.S. Treasury bills, bonds, and notes. Demand for these Treasuries affect all interest rates. Here's how. Treasury notes, backed by the U.S. government, are the safest investment in the world. They can offer the lowest yield. Investors who want more return, and are willing to take on more risk, will buy other bonds, such as municipal or even junk bonds. When demand for Treasuries is high, then interest rate yields can be low for all debt. When demand for Treasuries is low, then interest rates must rise for all debt on the secondary market.
There is a direct relationship between Treasury notes and mortgage interest rates. When yields on Treasury notes rise, so do interest rates on fixed-rate mortgages. Since fixed-income financial products compete for the notice of the “safe returns” investor, these all need to keep their returns on par with each other.
As confidence returns in the secondary mortgage market, it returns to all secondary markets. Ian Salisbury of Marketwatch mentions this in his August 25, 2012 article, “How an Obscure Bond Play Could Help Consumers." In 2007, auto and credit card securities were at $178 billion but plunged to just $65 billion by 2010.By 2012, they had recovered to $100 billion, according to Standard & Poor's.
Why is this secondary market returning? Large investors are now more willing to take a chance with securitized loans from reputable banks because Treasury note yields are at 200-year lows. That means the quantitative easing by the Federal Reserve helped restore functioning in the financial markets. By buying U.S. Treasurys, the Fed forced yields lower and made other investments look better by comparison.
The result? Banks now have a market for the securitized loan bundles. This gives them more cash to make new loans.
How the Secondary Market Affects You
The return of the secondary market is especially useful for you if you need a car loan, new credit cards, or a business loan. If you've applied for a loan recently and were turned down, now is a good time to try again. But if your credit score is below 720, you will have to repair your credit. There are ways and great free tips to repair your credit yourself.
It's also great for economic growth. Consumer spending generates almost 70 percent of the U.S. economy, as measured by gross domestic product. In 2007, a lot of consumers used credit card debt to shop. After the financial crisis, they either cut back on debt or lost credit from panicked banks, which denied them access. A return of securitization means investors and banks are less fear driven. Consumer debt is rising, boosting economic growth.
It would be good for you to know how your credit card debt compares to the average. If it is much lower than the average credit card debt, you are doing well. On the other hand, if your debt is higher than average, you might find yourself in a financial bind trying to pay this off.