Mortgage Backed Securities
Subprime Defaults Have Forced Downgrades in the RMBS and CMBS Market
Today Standard & Poor’s prepares to downgrade an additional 11 mortgage back securities. This is essentially yet another domino in the loan line of mortgage failures over the past six months. Many consumers are unfamiliar with commercial and residential mortgage back securities; however, these financial instruments have a huge effect on residential mortgage rates and their ability to obtain loans.
What is a Mortgage Backed Security?
Mortgage Backed Securities (MBS) are bonds that are issued by a variety of companies that are collateralized by mortgages. Commercial mortgage backed securities (CMBS) are collateralized by commercial mortgages; while residential mortgage backed securities (RMBS) are collateralized by residential mortgages. This is important because the form of collateral dictate the interest rates that bond holders received.
This is very similar to the way your mortgage is collateralized by the home you live in. MBS are typically lower risk than corporate loans because they are backed by hard assets (your homes). Furthermore, they are organized into a variety of credit areas. Strong creditworthy borrowers make up the lowest risk loans, while weaker credit borrowers make up the higher risk.
To create these securities investment banks buy standard loans from a variety of banks and mortgage lenders. This is the reason why most home loans have a very standard form and have very specific credit requirements. Banks are also very hesitant to provide non-standard financing because they typically cannot sell these off to investment banks.
How does the MBS Market Benefit Consumers?
Banks have very stringent lending requirements. In order to continue to lend money, they have to have a certain amount of cash available to pay off the people who have deposits. Additionally, they have to have money to lend. By selling loans to banks, they keep their supply of money available to lend to consumers high.
Bottom line, the Mortgage Backed Securities helps banks maintain a strong cash position. This keeps loan interest rates down and aids in the availability of cash for banks to lend. Without a strong MBS market, many more consumers would be unable to obtain loans regardless of their credit score.
What does the Mortgage Backed Securities Market’s Issues Mean to Consumers?
This could mean higher mortgage rates for consumers in the near future. As MBS get downgraded it becomes more expensive for banks to sell their loans. Essentially they get less money for the loans they sell, providing them less money to then lend out. Additionally, investors will be wearier of these markets because of the price fluctuations that accompany downgrading.
While it is not important for consumers to actively watch the MBS market, it is important to understand that as the subprime lending fallout affect this market; interest rates will increase.
