January 29, 2013
Fuster and Vickery have posted Securitization and the Fixed-Rate Mortgage, a FRB of NY Staff Report. This paper brings some empirical research to the debate over the proper fate of the 30 year mortgage. Commentators are sharply divided over whether the government must be intimately involved in the operations of the residential mortgage markets in order to keep the 30 year FRM available in the United States. (Whether that is a worthy goal is another question entirely.)
Peter Wallison at the American Enterprise Institute has argued that the existence of 30 year FRMs in the jumbo market demonstrates that the government does not need to play an active role in the mortgage markets to ensure the availability of that mortgage product. David Min, formerly of the Center for American Progress, has argued that the government must continue to play an active role in order to keep that product in the market. My own position has been in the middle — the government can reduce its dominant role in the mortgage markets while retaining a role during financial crises.
Fuster and Vickery test whether securitization, by allowing interest rate and prepayment risk “to be pooled and diversified, increases the supply of FRMs relative to ARMs.” (1) They find that “lenders are averse to retaining exposure to the risks associated with FRMs in portfolio. Securitization increases lenders’ willingness to originate FRMs by transferring these risks to a diverse international pool of MBS investors.” (2) Unsurprisingly, they also find that “when private MBS markets are liquid and well functioning, as in the period before the onset of the financial crisis in mid-2007, private and government-backed securitization perform similarly in terms of supporting FRM supply. However, public credit guarantees may make securitization less susceptible to market disruptions, thereby improving the stability of FRM supply.” (2) Fuster and Vickery suggest that the current GSE- centered mortgage finance system may not be necessary for FRMs to remain widely available at competitive rates, but only as long as private securitization markets are liquid.” (30)
Fuster and Vickery do not mean to say that they have produced the last word on this topic, but their findings are intuitive to me. This debate is central to any plan for the future of the American housing finance system, so more empirical work in this area is most welcome.| Permalink