King Solomon’s advice on prosperity and money management is always tempered by a sense of justice, as his words in the book of Proverbs reveal. In Proverbs 22:16, the fabled monarch says, “He that oppresseth the poor to increase his own riches, shall himself give to one that is richer, and shall be in need.” In the world of investing, too, under some circumstances a negative can become a positive.
Mortgage backed securities, or MBSs, played a significant role in the housing collapse of 2008. Now these instruments, bought and sold in the secondary mortgage market among financial institutions, lenders and even individuals, may be making a contribution to its recovery. And, if backers of the Fed’s plan to buy up billions of dollars in MBSs are right, these securities may also help to reinvigorate the US economy as a whole by boosting home sales.
Mortgage backed securities are financial instruments whose value is backed by various types of mortgages serviced by banks and other lenders. Like other securities they can be bought and sold; but buyers of these securities are not purchasing the mortgages themselves, only the value they represent. For that reason these securities are called derivatives, because their value is derived from the underlying asset – in this case, mortgages.
The concept of creating and selling MBSs was born in 1968 as part of the Charter Act that created Fannie Mae (the Federal National Mortgage Agency). This allowed financial institutions other than banks to hold mortgage loans, which contributed in part to the massive housing collapse of 2008, when banks and other institutions offered mortgages with wild abandon, knowing that they could sell the loan before a homebuyer defaulted.
When a bank, mortgage company or other lender makes a home loan to a home buyer or investor, they may then sell that loan to an investment group or one of the federal mortgage superagencies, Fannie Mae, Freddie Mac (the Federal Home Loan Mortgage Corporation), or Ginnie Mae (the Government National Mortgage Association). These and similar agencies bundle together large groups of loans with similar interest rates and other features, and then sell a security that provides the same amount in payments as the original bundle of loans.
Those mortgage-backed securities are then sold on the secondary mortgage market, which allows ways for banks to sell and resell mortgages. This keeps mortgages moving and frees up funds that can be offered to new borrowers. Mortgage backed securities are bought and traded by investors of all kinds, typically institutions and corporations, although individual investors may buy them too.
Although MBSs are sold by various financial entities, those sold by Fannie Mae, Freddie Mac and other governmental bodies hold particular appeal for investors because the returns on those loans are guaranteed by the sellers, who themselves are backed by the Federal Reserve. In fact, Ginnie Mae offers a guarantee that investors purchasing its securities will receive the payments on them.
Now, MBSs may have come full circle. Although they may have kick started the housing collapse, now they may be riding to the rescue. Because the Fed and its associated agencies are buying op to $85 billion in mortgage baked securities per month, mortgage rates are staying low for now, encouraging investors working with Jason Hartman’s principles to take the first steps in income property investing.
The Solomon Success Team