The term securitization refers to the process of converting assets with predictable cashflows into securities that can be bought and sold in financial markets. In other words, securitization allows financial institutions to bundle and convert illiquid cashflow-producing assets held on their balance sheets, such as individual mortgage loans or credit card receivables, into liquid securities.
For decades, one of the largest sources of consumer financing has been the securitization market. Securitization has helped consumers obtain credit to finance houses, cars and college educations; and it has helped companies to grow – and in turn create jobs for the U.S. economy – by providing additional sources of funding for lenders who extend the credit needed by consumers and businesses. Securitization facilitates the flow of capital from investors located around the world into U.S. credit markets, making credit more widely available to consumers and lowering the cost of that credit.
The bonds created by securitizing mortgage loans are widely known as mortgage-backed securities (MBS). Bonds collateralized by other types of assets, such as student loans, small business loans, or credit cards, are generally referred to as asset-backed securities (ABS).
MBS may be further divided into two general categories: 1) MBS issued by one of the Government-Sponsored Enterprises (GSEs), known as "Agency MBS"; and 2) MBS that is issued by private financial institutions, known as "Private-Label" MBS. The GSEs and Ginnie Mae are charged with enhancing the flow and reducing the cost of credit for housing in the U.S.
Institutional investors who purchase ABS and MBS generally receive interest and principal payments on their investment as the debtors in the underlying pool of assets pay off their debt – for example, as a homeowner pays off his or her mortgage loan.
As housing prices peaked and then began to decline throughout 2008, many borrowers began to default on their mortgage loans. Since many of these mortgage loans were the underlying collateral for many securitizations, the markets for private-label securitized products saw a decrease in liquidity and, in some cases, significant declines in price. Agency MBS markets also experienced some shorter-lived disruptions but generally remained liquid. As a result, the amount of financing available to consumers and businesses that were dependent on the private-label markets became restricted and its costs increased – a condition known as a credit crunch.
Government initiatives, such as the Term Asset-Backed Securities Loan Facility (TALF), were implemented to stimulate the securitization market and help ensure the continued availability of credit to consumers and small businesses. TALF appears to have played a positive role in the return of liquidity to the various consumer ABS markets it was designed to serve; however, more work remains to be done before the markets for non-Agency MBS return to healthy levels of activity and fulfill their purpose in promoting the availability of credit.
On February 11, 2011, the Obama Administration released a report to Congress that provides a useful analysis of what led to our current situation and identified many important areas related to housing finance that should be addressed by Congress. Amongst the topics discussed in the report were the eventual wind down of Fannie Mae and Freddie Mac and minimizing the role of the government in broader housing finance. The report also provided comfort that GSE obligations will be honored.
To promote healthy lending, it is necessary to revive the securitization markets. Some efforts underway have been to tighten the underwriting practices of the underlying mortgage loans; implement national mortgage lending standards and stronger oversight; increase market transparency; advocate for mandatory risk retention; and ensure the quality and integrity of credit ratings.
SIFMA is deeply engaged in the myriad of industry, regulatory, and legislative efforts that intersect with the securitization markets because the recovery of these markets and the restoration of healthy lending are essential to the recovery of the broader economy. Our goal is to help regulators design a regulatory regime that addresses shortfalls and gaps in previous standards, without impeding a recovery of the securitization market.
SIFMA is also focused on overall housing finance reform in the U.S., including the future of the GSEs. Although this will be addressed separately from Dodd-Frank, it is inextricably connected to the future of the non-agency mortgage securitization markets, as well as the future of mortgage lending in the U.S. SIFMA welcomes the Administration’s interest in focusing on issues surrounding the GSEs. SIFMA believes the most important objective is to ensure a smooth and orderly transition that does not harm the still fragile housing markets or the nascent economic recovery. SIFMA urges policymakers to fix the parts of the housing finance system which need attention without dismantling the aspects of the system that have provided efficient, cost effective lending and benefits to our economy for the last 30 years.