Market for Securities Backed by Mortgages May Suffer

Article excerpt

WASHINGTON - The savings-and-loan bailout plan is intended to restore that industry to health.

But in the process, the market for securities that are backed by home mortgages may suffer some ill effects of its own.

The dramatic consolidation of savings institutions is causing a wave of selling of those securities.

This kind of activity, mortgage experts say, could persist for two years, though they are divided about the extent to which such selling could drive down the prices of the securities, or even throw the market into a slump.

Some analysts say the market has matured and has certain strengths that will help it survive heavy selling.

Perhaps most important, there are some new players, including commercial banks and big pension funds.

And Wall Street has come up with some new, more flexible mortgage products to appeal to a broader array of investors.

But the bailout plan makes one thing certain: Both healthy and insolvent savings units will be shedding assets to raise cash.

Some will need capital to bolster reserves and improve their financial health, to meet the stricter guidelines of the new law.

Those that are closing will need capital to pay off depositors.

According to James R. Barth, chief economist for the Office of Thrift Supervision - the former Federal Home Loan Bank Board - which is overseeing the bailout, the assets most likely to be sold first are mortgage-backed securities, which are among the most liquid assets in the typical savings and loan's portfolio.

In fact, analysts are predicting that savings institutions may eventually sell as much as $180 billion in mortgage-related securities to Wall Street dealers in the next two years, about one-quarter of the outstanding issues.

The securities generally consist of thousands of individual homeowner mortgages bundled together in pools.

The Wall Street dealers, who act as intermediaries for the securities, say they are becoming uneasy about the prospect of finding investors for these securities for several reasons.

- Because mortgage rates have fallen in recent months, increasing numbers of home buyers are seeking fixed-rate 30-year loans, instead of adjustable-rate mortgages. The June survey by the Federal National Mortgage Association, or Fannie Mae, showed that the number of fixed-rate loan applications rose 34 percent over the priormonth, three times the growth of adjustable-rate mortgages. The mortgage securities market is predominantly for fixed-rate mortgages, which are more liquid, and will have to absorb these new loans.

- People already holding adjustable-rate mortgages are expected to swap them for fixed-rate loans to lock in lower interest rates, further swelling supply. Drexel Burnham Lambert Inc. reports that this activity could add a net of $8 billion to $28 billion to the mortgage marketplace over the next several months.

- As a result of the April 1987 bond market crash and the October 1987 stock market crash, many brokerage firms that handle mortgage-backed securities have cut their staffs and the risk capital committed to dealing in the securities. The ability of the mortgage market to handle unusual activity is thereby weakened, some mortgage executives said.

Already, the sales of mortgage-backed securities by savings institutions and the fears on Wall Street about the extra supply have driven up mortgage yields by 30 to 50 basis points over Treasury market yields since the beginning of the year.)

The yield spread between these two markets is a measure of how well mortgage securities are performing.

When the yield on a mortgage security rises significantly faster or falls significantly slower than yields on Treasury notes of comparable maturity, it is a signal that investors are demanding price discounts. …