What Moves the Mortgage-Backed Securities Market?
Xu, Xiaoqing Eleanor, Fung, Hung-Gay, Real Estate Economics
Using a vector autoregressive model with monthly data from 1988 through 2001, this study investigates the factors that drive the excess returns on a widely followed mortgage-backed securities (MBS) index. We find that eight important economic variables (industrial productions, new home sales, bond horizon premium, bond quality premium, mortgage rate, refinancing proxy, general stock market index and world bond market index) appear to move the excess returns on MBS. Impulse response analysis and variance decomposition further indicate a strong dynamic relationship between MBS excess returns and changes in these economic variables. Additional analysis of Freddie Mac and Fannie Mae MBS also indicates that the risk of the MBS guarantor is an important determinant of the MBS return dynamics after the creation of the Office of Federal Housing Enterprise Oversight.
The mortgage debt market has become an increasingly important component of the U.S. capital market in the past two decades. Mortgage-backed securities (MBS) in particular, which are created through securitization of mortgage loans made by financial institutions such as commercial banks, savings and loans and mortgage companies, have come to dominate the mortgage debt markets in recent years.
The MBS market has grown at a much faster pace than the overall mortgage market because an increasing proportion of mortgage originations are now securitized. As of 2001, the value of U.S. MBS outstanding amounts to about $3.7 trillion, about half the size of the total U.S. mortgage debt market and equivalent to 36% of U.S. gross domestic product. Advances in financial engineering and structured finance techniques, increased availability of consumer credit information and standardization and credit support from government agencies are credited for the success of the U.S. MBS market. Table 1 and Figures 1 and 2 illustrate the dramatic development of the MBS market over the past 25 years.
This study uses a vector autoregressive (VAR) model to examine the economic factors that are important for the excess returns on a widely tracked and followed MBS index (i.e., the total return on MBS index minus the 3-month risk-free Treasury bill rate). This is a new approach applied to the MBS research, although the VAR model has been used in the literature related to traditional financial and real estate market analysis (see, e.g., Hasbrouck 1991, Lee 1992, Liu and Mei 1992, Campbell and Ammer 1993).
[FIGURE 1 OMITTED]
Most MBS are in the form of mortgage pass-through securities. A mortgage pass-through security is created when mortgages with similar loan types, coupons and maturities are pooled and when participations in the pool are sold. (1)
[FIGURE 2 OMITTED]
The great majority of mortgage pass-through securities have been issued or guaranteed by three government agencies created by the U.S. Congress to enhance liquidity in the secondary mortgage markets. The three agencies are commonly called Ginnie Mae (Government National Mortgage Association, GNMA), Fannie Mae (Federal National Mortgage Association, FNMA) and Freddie Mac (Federal Home Loan Mortgage Corporation, FHLMC). Ginnie Mae is a government agency within the Department of Housing and Urban Development (HUD), whose guarantee assumes the full faith and credit of the U.S. government. Fannie Mae and Freddie Mac are New York Stock
Exchange-listed "government-sponsored enterprises" (GSEs), which do not represent the explicit guarantee of the U.S. government but are believed by market participants to convey the government's implicit guarantee. The explicit (for Ginnie Mae MBS) or implicit (for Fannie Mae or Freddie Mac MBS) guarantee of the three federal agencies has made investments in MBS more attractive, as credit risk is either eliminated (for Ginnie Mae MBS) or substantially reduced (for Fannie Mac or Freddie Mac MBS). The Office of Housing Enterprise Oversight (OFHEO) was established in 1992 to "promote the housing sector and a strong economy by ensuring the safety and soundness of Fannie Mae and Freddie Mac and fostering the vitality of the nation's housing finance system. …