The Use of Mortgage-Backed Securities in International Comparative Perspective: Lessons and Insights

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ABSTRACT

The secondary mortgage market in the United States has helped millions of people purchase homes over the past hall century. Following the burst of the real estate bubble and the credit crisis, it is important for American policymakers not to lose sight of the importance that the secondary mortgage market has played in increasing home ownership. The financial engineering in the form of securitization that led to the success of the secondary mortgage market needs to be preserved, although it should also be reworked so that the externalization of unappreciated risk is reduced and the possibility of a large-scale financial meltdown of the kind experienced in 2008-2009 is not experienced again. In this respect, American policymakers could use ideas from other countries, where synthetic securitization is the key financial tool that has helped the secondary mortgage market to develop. Synthetic securitization offers ways of reducing default risk by integrating financial derivatives such as credit default swaps into the instrument. Such an arrangement also offers the possibility of making securitization more transparent, consequently providing investors new ways of assessing risk and reducing their reliance on credit ratings agencies, and in turn hopefully reducing the concomitant systemic risk that the widespread use of these instruments has created.

TABLE OF CONTENTS

  I. INTRODUCTION

 II. BACKGROUND: THE MORTGAGE MARKET IN THE
     UNITED STATES
     A. Traditional Lending Institutions as the
        Early Key Players
     B. The Beginning of Government Involvement
        in the Mortgage Market
     C. Securitization and the Secondary Mortgage
        Market Take Off
        i) The Government Agencies' Involvement
           in Securitization
        ii) Private-Label Securitization
     D. The Role of the Credit Rating Agencies
     E. The Misalignment of Originator Incentives
        Inherent in Traditional Securitization

III. SYNTHETIC SECURITIZATION: AN ALTERNATIVE
     METHOD OF WEALTH GENERATION
     A. How Synthetic Securitization Works
     B. The International Use of Synthetic
        Securitizations for Mortgage Financing
        i) Pfandbriefe and the History of the
           German Secondary Mortgage Market
        ii) Pfandbriefe and the Emerging
           Securitization Market in Germany
     C. Shortcomings of Synthetic Securitizations
     D. Rescuing Derivatives from Becoming the
        Bogey-Men of the Financial World

 IV. USING SYNTHETIC SECURITIZATION IN TRADITIONAL
     SECURITIZATION TRANSACTIONS TO PROMOTE
     TRANSPARENCY
     A. What is the Problem We Need to Address?
     B. Current Legislative and Regulatory
        Proposals--On the Right Track?
     C. Possible Alternatives
        i) Public Benchmarks for Securities Prices
        ii) Combining Synthetic and Traditional
           Securitization
        iii) Shortcomings of This Approach

  V. IMPLEMENTING THE PROPOSAL UNDER THE U.S.
     SECURITIES LAWS
     A. Regulation of Mortgage-Backed Securities
        Today
     B. Regulation of Mortgage-Backed Securities
        Going Forward

 VI. CONCLUSION

I. INTRODUCTION

The subprime crisis in the United States delivered one of the largest shocks to the American financial system in decades. (1) Although the total impact of the crisis is not yet clear, the collapse of the subprime market ravaged international credit and equity markets, which in turn threatened the stability of economies around the world. (2) The reaction from the American public has generally been one of outrage. (3) They see the financial system as having failed ordinary people by cajoling them into mortgages they did not understand through predatory lending practices and enriching the financial elite at the expense of everyone else. (4) The American public is demanding greater government vigilance to ensure that a similar crisis does not happen in the future. …