The Wall Street Journal reported this week that the Obama administration, under the auspices of the Federal Housing Finance Agency (FHFA), is considering ways for US mortgage agencies Fannie Mae and Freddie Mac to effectively syndicate the risk of the guarantees backing various pools of mortgages. This would be done by selling off a “first loss” piece on pools of mortgages to private capital/investors, who in turn would be compensated with a higher yield for the risk they would be assuming. The example cited suggested the bottom 5% or 10% of a pool would be “engineered” and sold to institutional investors. Any underlying losses would be directed against the first loss slice. The appeal to investors would be a function of the offered yield and the fact that agency underwriting standards have become increasingly conservative and projected losses on a given pool of mortgages would be muted.
Since the advent of the 2008 financial crisis, there have only been three public securitizations on new origination mortgages totaling less than $1 billion. Contrast that with 2005 and 2006 issuance that both exceeded $1 trillion. Since the summer of 2007 when the Bear, Stearns Hedge Funds were liquidated and the market discovered that AAA wasn’t really AAA, private mortgage securitization has effectively been frozen. The flip side of that coin is that essentially all securitized mortgages have needed a government guarantee to attract investor interest. As a result, the pool of capital available for non-conforming mortgages, i.e. those that do not meet Agency underwriting criteria, is severely diminished and is essentially restricted to portfolio lending.
The FHFA initiative may represent a first step to attract private capital and simultaneously reduce the market’s quasi exclusive dependence on Uncle Sam to finance residential mortgages.
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