Editor: David Reiss
Brooklyn Law School

May 19, 2016

Divvying up The Mortgage Market

By David Reiss

photo by Evan-Amos

S&P Capital IQ has posted some Structured Finance Research: The Conforming Loan Limit And Its Effect On The U.S. Private­-Label Mortgage Market. It contains interesting thoughts on how a stabilized secondary mortgage market should be split between government-backed and private-label securitizations. More particularly, it finds that

  • The U.S. private­-label mortgage market has failed to recapture the market share that it ceded to the agency [Fannie & Freddie] market after the financial crisis of 2007–2009.
  • Partly because of changes in underwriting requirements, the private­-label market is synonymous with jumbo collateral: loans that exceed the conforming loan limit set by the Federal Housing Finance Agency (FHFA).
  • As a result, the conforming limit now acts as a gateway, controlling how much financing and securitization volume is accommodated by the agency channel relative to that of the private­-label market. (1)

It notes, “As rising home prices restore the historical relationship between the conforming limit and median home price, it will be interesting to see if there is a corresponding return to the pre­-2003 market share split between agency and private­-label securitization.” (Id.)

S&P further explains that

For the last 10 years, the conforming limit (which herein excludes dwellings with more than one unit) has remained at $417,000. Historically, the ratio of the median new home sale price to the conforming loan limit has been near 50%. When the housing market crashed, the ratio dropped to near 40%. However, the recovering housing market is restoring the historical relationship. Because the conforming loan limit acts as mechanism to regulate the market share breakdown between the private­-label and agency markets, it is likely to be a determinant in the future growth of the struggling private­-label sector.

Private-Label/Agency Market Share

Prior to 2003, the market share of the agency sector was a bit greater than 80%, with the remainder being private­-label issuance. After 2008, however, the agency share rose to over 95%. So while a new equilibrium appears to have been achieved, it is one in which a good deal of market share has been shifted away from the private-­label market and absorbed by the agencies. While the general market consensus seems to be that the private­-label share might not reach 2005–2007 levels again, the question remains as to when (if at all) the private­-label mortgage market will recover to the levels of issuance prior to 2003.” (1-2, chart omitted)

Implicit in all of this is that the pre-2003 state of affairs reflects some kind of natural state of equilibrium. This ignores the fact the national mortgage market has always been one that the government has shaped. While it is worth considering what balance between government and private-label securitization is best, historical precedent in itself is an insufficient guide.

I would rather focus on fundamentals. Should the government subsidize residential mortgages? How much exposure should the government have to credit risk? How much credit risk can the private sector handle? Should the government incentivize the origination of mortgage products (like the 30 year FRM) that private-label investors might not find so attractive? I care about the answers to these questions a whole lot more than I care about how the secondary mortgage market was divvied up one or two decades ago.

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