Wall Street Trading
With the mortgage bailout bill playing center stage on all of the national news stations, I thought it was the perfect time to release the second post in my basic mortgage education series. The first post of this series covered the history of mortgages and mentioned that the second post would explain what the secondary market is, and who the major players in the secondary market happen to be.
To start with, we will cover some definitions. Since I always like to have examples to help me wrap my head around concepts, I decided to provide an example for each lender class.
· Commercial bank - Nongovernmental financial institutions. Sometimes called full-service banks because they provide a wide range of services including checking and savings accounts, credit and loan arrangements, consumer and business loans (generally short-term with full recourse to the Borrower), and safety deposit box rentals. Commercial banks also sell and redeem US savings bonds. A good example of a commercial bank is Bank of America.
· Savings and loan – A federally or state chartered financial institution that takes deposits from individuals, funds mortgages, and pays dividends. These institutions are required by law to provide home mortgages as a certain percentage of their loans. An example of a savings and loan would be the previous World Savings that was swallowed by Wachovia. Not many of these banking entities exist as most of them failed during the early 90’s in what has been called the savings and loan crisis.
· Thrifts - A depository financial institution intended to encourage personal savings and home buying. Washington Mutual is a good example of a thrift.
· Mortgage Brokerage – An organization that is hired by large institutional lenders, such as pension funds of large unions or commercial banks. Most mortgage brokerages are small independent organizations such as Lone Star Funding.
If, after reading these definitions, it is not clear to you what the difference is between these institutions, it is not an absolute must in order to understand the secondary market, and you are not alone. In the end the differences are really in the legal regulations that govern them.
Whether someone applies for a mortgage through a commercial bank, a savings and loan, a thrift or a mortgage brokerage, the institution is known as the primary originator of the mortgage. Companies that later purchase loans from primary originators are referred to as secondary originators, because they sell the loans in the secondary market. Primary originators package a large number of loans together and then sell them off to one of the three main purchasers of mortgage loans: Ginnie Mae (GNMA), Freddie Mac (FHLMC) or Fannie Mae (FNMA). Once one of these groups purchases the loans, they are split up into smaller pools, and the principal and interest payments made by individual home buyers are then combined to create mortgage-backed securities. These securities are subsequently sold on Wall Street to individual or institutional investors as bond class investments. By selling off these bonds FNMA, GNMA and FHLMC refill their coffers, which allows them to purchase more loans from primary originators, thereby allowing the primary lenders to make more loans to consumers.
The breaking of this chain is what has caused the subprime crisis, sending a shivering shock through the entire credit market. In my next post in this series, we will cover the rolls of secondary originators such as Fannie Mae and Freddie Mac.
December 10th, 2008 at 12:59 am
Great explanation so far! I think it is important to note that a contributer to the break in the chain was how the mortgage backed security’s risk was incorrectly assessed and presented to the buyers on wall street. They didn’t really know what a risky investment they were buying.
December 16th, 2008 at 12:36 pm
Great Explanations! Even as a real estate professional its hard to totally comprehend what is happening with these mortgages. I think our biggest problem was underwritting was so lax that people got away with way to much.
December 22nd, 2008 at 11:57 am
There were many contributing factors to what has become the “subprime meltdown”. Ultimately, the result has been a return to common sense underwriting where you can buy a house if you can afford. A simple concept that was lost on buyers with a “gotta have it now” mentality and lenders with dollar signs in their eyes.
In today’s market, there is no shortage of money to lend to buyers who can afford to own a home and have a proven willingness to repay debt (credit history). Maybe thats the way it should have been all along.
December 31st, 2008 at 8:29 pm
This issue gets so confusing - especially when you throw in issues like loans that are sold on the secondary market but the servicing of them might stay with the original lender. Hopefully a few more of your readers have an understanding of this issue.
December 31st, 2008 at 10:51 pm
Thanks Carolyn,
I have not decided on how much I want to get into the servicing of loans. For the most part the only way it impacts the consumer is they write the check out to a different name and put a different address on the envelop.
Now on the mortgage banking side of things servicing loans is a huge revenue center.
January 29th, 2009 at 11:39 pm
Nice story. I was sales director to a large construction lender and I saw this happening in the peak. Too much appreciation too fast and simple school teachers (example) able to qualify for four 100% construction loans. It’s like a game of Hot potato. Had to happen at some point and with prices i was watching I knew it was coming soon. FNMA, Mac, and Mae are responsible for this mess as any other.
February 10th, 2009 at 11:56 pm
Great post! To understand todays market with the proposed Government ideas.
The government needs to get all the money actually in the system so that the institution will promote their deals to the public. The new TALF -Term Asset-Backed Securities Lending Facility which was announced yesterday and promoted today 2/10/2009 brings money into the system.
The government is going to fund 90% of asset back securities with an investor’s 10% equity as non recourse loans.
I don’t know if it is the right thing, but if they are going to do it, they must get it done fast. The slipping must stop.
Richard
February 13th, 2009 at 7:37 am
The new name for this market - so you can easily understand is -
sub prime mortgages!
March 11th, 2009 at 7:41 pm
Great explanation! I as a realtor know enough to get me by and be dangerous. I want to so bad learn so much about the mortgage market but it seems so very in-depth (much like the real estate market when you first get in).
March 12th, 2009 at 10:55 pm
Great topic and description on how it works. I believe that everybody in the real estate industry should get a clear understanding as to how this works and the significance that it has on not only rates but also product availability. Unfortunately, even many loan officers do not know what “secondary market” even means. One of the many things that should we should all learn from the recent history of the housing crisis is that education by real estate professionals is extremely important from LO’s, realtors, appraisers, processors, etc. and how the entire cycle works. Great article!
March 31st, 2009 at 10:31 pm
Your post is good and a good service to others like me who do not know enough about the loan business. Clearly, it would take a lot of education to keep up with the changes over the past several months. Suffice it to say, loans are still available, but not to as many people as before. The criteria have tightened (re: the return of common sense in lending).
May 14th, 2009 at 5:21 pm
Thank you for this explanation. I had a vague idea of the different types of lenders, but you make it much simpler for me to understand. When you wrote this, the commercial banks were non-governmental institutions. Now, the government owns them–and will most likely run them. I’m wondering how will that affect mortgages.
June 29th, 2009 at 12:11 am
You’ve done a great job of explaining this complicated issue. I couldn’t have done it better myself!
July 16th, 2009 at 6:23 pm
Mortgages and the overall loan process is where I need a real professional to help me and the clients understand. I know some questions to ask but I am far from a mortgage expert.
July 31st, 2009 at 3:35 pm
Thanks for the succinct explanation of a very complicated subject. After many years as a realtor and broker, I still struggle to understand particular aspects of the lending market.
November 6th, 2009 at 11:52 pm
The problem right now is the government is really the only source to the secondary market.
Wall Street is not online. They are trying but it is miniscule.
We need a large secondary market for jumbo mortgages. the government doesn’t do them and the banks don’t really want them.