MORTGAGE BACKED SECURITIES 2.0 – PART ONE

Twice in the same week two entities published their recommendations on a new mortgage securitization process that would turn mortgages into tradable securities. Their motivation is to ensure that lending institutions are able to access the capital markets.

The need for a reset to MBS 2.0 is that the agencies responsible for purchasing and securitizing mortgages issued by lending institutions, Federal Home Loan Mortgage Association (FHLMC) and Federal National Mortgage Association (FNMA) were absorbed by the federal government. This action was in response to the credit crisis, increasing late payments and growing defaults by homeowners holding mortgages securitized by FHLMC and FNMA. Both agencies, known government sponsored enterprises (GSE), were public companies owned by shareholders before being taken over by the federal government.

Prior to the credit crisis the role of these agencies was to purchase qualifying mortgages, turn the mortgages into securities, and guarantee the timely payment of principal and interest, which were sold to investment banks who in turn sold them to investors. This process was established in the late 1960’s and was designed to provider lending institutions with a way to move the mortgages off their books and recapture the capital lend to home buyers.

Congress and the Federal Housing Finance Agency (FHFA) are struggling with finding a system to improve market liquidity and address the potential risks causing market disruptions. The ultimate solution will come from the federal government; particular focus will be on correcting some of the shortcomings of the original model, such as:

·        Implicit guarantee that the federal government would back the two GSE in the event of a crisis. This certainly was true……

·        Marginal impact on low to moderate income home buyers

·        Conflicts in regulations and between public and private objectives

A new securitization model is a critical step in the recovery and at a minimum, must ensure

·           Consistent, nationwide supply of mortgage financing for residential mortgages to qualified home buyers

·           Assistance to low and moderate income homebuyers, i.e. subsidized mortgages

As I wrote in an earlier blog, the ideal response to this opportunity will be a result of a collaborative effort between Congress, FHFA and representatives from the Capital Market. This mix of interests will ensure that each is represented and that the model will be a “best practice” approach to the stated objectives. At this point the following are some of the broad principles that should be addressed:

·        Securitization model that combines a federal government and private industry guarantee that timely principal and interest payments will be paid to investors on qualified mortgages

·        Transparency on the underlying mortgages in any securitized pools or tranches sold to investors

·        Investment grade rating on the securitized pools or tranches

I will review the recommendations offered and explore this topic further in another blog. Meanwhile, let me know your thoughts regarding..

What is your opinion about this?

Your ideas on the new securitization model?

Are there other viable alternatives available?

WHAT'S UP WITH THE LEGAL ENTITY IDENTIFIER?

It’s been a while since the need for recognizing legal organizations and their related entities has been identified. There have been a number of announcements on initiatives but little definitive movement on a coordinated global response to LEI.

Remember that it was difficult to determine their exposure of derivative trades especially for firms, like Lehman, that were facing a credit crisis. The initial drive for LEI was the Dodd Frank Act (DFA) and European Market Infrastructure Regulation (EMIR). Their focus was to reduce counter-party and systemic risk related to derivatives trading and settlement.

February 12^th was the date for SWAP trades to be processed with LEI. Problems were expected but the news about this event has been sparse.

What are your thoughts, good, bad or neutral, concerning global legal entity identifiers?

                        Are the regulators ready to respond to reported anomalies?

                                 Should a global identifier be extended to other assets?

SUPERVISORY COLLEGES FOR INTERNATIONAL CREDIT RATING AGENCIES

These organizations were established as a result of recommendations that the International Organization of Securities Commissions (IOSCO) made in their final report published in July 2013.  Supervisory Colleges for International Credit Rating Agencies creates a mechanism for sharing and discussing information regarding:

• Compliance with local or regional laws and regulations
• Implementation of, and adherence to, the IOSCO Code of Conduct for CRA
• Establishment and operation of rating models

•  Methodologies, internal controls, procedures to manage conflicts of interest
• Procedures for handling material non-public information
• With the goal of promoting better understanding of the risks faced or posed by international CRA and how relevant supervisors are addressing these risks

One lesson learned, was that credit rating agencies face conflicts. The Supervisory Colleges are a creative approach to avoiding similar missteps.

The colleges for S&P and Moody’s will be chaired by the Securities and Exchange Commission (SEC) and the college for Fitch will be chaired by the European Securities Markets Authority (ESMA. The SEC

              What’s your opinion about the need for supervision of credit rating agencies?

     Is this an appropriate response?

What are the critical best practices for the CRA?