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Answer:
Dear
BuyandHolder,
The Definition...
Let’s begin with figuring out what mortgage backed securities are.
It may help to know that they are also called “pass through” securities. That’s because mortgage payments (interest and principal) made by borrowers are passed through to investors who buy these securities. In other words, they are essentially packages of loans, assembled in pieces and sold to investors.
Note: It’s not the mortgages per se that are being sold to investors but rather securities based on slices of the mortgages.
It all begins when home buyers take out mortgages from banks or lending companies. These primary lenders can then sell your mortgage and mine to what the SEC calls “governmental, quasi-governmental or private entities.” These “entities” then bundle or pool the mortgages into securities for sale to hedge funds, mutual funds, insurance companies, pension funds and the public.
The most commonly known “entities” are the Federal National Mortgage Association (FNMA) aka, Fannie Mae and the Federal Home Loan Mortgage Corp. (FHLMC) aka, Freddie Mac. However, there are others, including brokerage firms (remember Bear Stearns!) that participate in this process -- purchasing mortgages from primary lenders and using monthly payments to pay investors who buy shares.
For more details on these and other types of mortgage backed securities go to the SEC’s Web site: (www.sec.gov/answers/mortgagesecurities.htm).
Fannie Mae (800-732-6643, www.fanniemae.com) and Freddie Mac (703-903-2000, www.freddiemac.com) also provide clear information.
The Problem
The current problem stems from securities filled with subprime mortgages –- home loans made to consumers with poor credit histories and who, when faced with an increase in the cost of living or loss of job, are likely to default on their loan payments.
Back in 2005, Congress rejected a bill that theoretically would have reduced the risky portfolios held by Fannie and Freddie. Those that rejected it were in favor of making home ownership available to more and more Americans. Those who were in favor of curbing the agencies felt they were not paying attention to business. Arguments can easily be made for both positions.
Fannie and Freddie had encouraged home ownership by encouraging banks to lend more money and then buying loans from these very same banks and guaranteeing them. This appeared to work for quite some time, with the stocks of both agencies soaring and many Americans owning a house for the first time. And, as you know from the news, Fannie and Freddie executives were paid way above minimum wage!
Then the economy weakened. People were laid off. Workers had their hours cut. The cost of milk, bread and gasoline skyrocketed. And, not surprisingly, the housing market ran into trouble. By this time, Fannie and Freddie had thousands of loans on which homeowners defaulted. Foreclosures began. And the rest is history.
You may feel Congress should have reduced the increasingly risky investments made by Fannie and Freddie. Or you may be in the camp that believes government should not control free enterprise.
Meanwhile, governments in the 15-nation eurozone have agreed to help trouble banks in their individual countries, launching a coordinated approach to the financial problem surrounding much of the world.
Next week... we’ll continue our coverage of what’s happening on the financial scene.
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