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Urban Institute's Goodman: Resurgence of private-label MBS is necessary

Fri Oct 30, 2015 13:45 PDT

Urban Institute#39;s Goodman: Resurgence of private-label MBS is necessary

After the housing crisis, the market for private-label residential mortgage-backed securities (MBS) collapsed and has not yet bounced back. Many analysts, however, say a healthy housing market must include a robust private-label MBS market, which has historically provided the capital to finance jumbo and subprime loans that fall outside of the guidelines of conventional loans backed by Fannie Mae and Freddie Mac. Laurie Goodman, director of the Housing Finance Policy Center at the Urban Institute, recently authored a paper on private-label securities. She spoke with Scotsman Guide News about what needs to happen for the market to come back. 

What is the state of the private-label securities market right now?

Issuance is just extraordinarily low, and there is basically a low level of prime loans being securitized and almost no Alt-A or subprime loans being securitized.

Why did the market for private mortgage-backed securities collapse to a greater degree than those backed by other asset classes?

I think there are three reasons for that. The first is that mortgages experienced the most severe dislocation of any asset class and these dislocations highlighted the flaws in the cash flow waterfall and the unexpected surprises in the collateral itself, like how many liars loans there were and that sort of thing. A second factor is that mortgages were the only asset class where you had significant policy changes affecting already outstanding securities. There were some changes in other asset classes, but they apply only proactively, whereas the changes in mortgages applied retroactively, which, of course, makes sense given that one's home is often their single largest asset. The third thing is that the interests of the investors and issuers are largely aligned in most other asset classes, whereas private-label securities were riddled with conflicts of interest.

Why should people be concerned that these securities haven't returned?

If you are a more risky borrower who lies outside the agency space, you will have a hard time getting a loan. Because private-label securitizations are so low, you are probably not squeezing out any pristine jumbo borrowers. The reason pristine borrowers who are above jumbo limits are getting mortgages is because bank lending is very robust. You can't count on bank lending being very robust forever. The real problem is going to be when banks stop being willing to portfolio loans. What happens to these borrowers? You will find that borrowers are totally unable to get a loan without a private-label market that functions.

The private-label market was, in part, blamed for the crash. Some people says that if the market comes back, it will create more risk.

There were a lot of factors that contributed to the crisis. Certainly, what the crisis highlighted was both flaws in the collateral and flaws in the structure of the private-label market. We have gone a long way toward cleaning up the collateral. The qualified mortgage rules that went into effect essentially codified what the market had already done. Right now, everything is fully documented. You make sure the borrower has the ability to pay. You don't have interest-only loans or nonqualified-mortgage loans. You don't have negative amortization loans anymore. [The crisis] also highlighted weaknesses in the structure of the securities themselves. We have made some changes in terms of the cash flow waterfall, where investors are better protected than they ever were before. Investors have a lot more information than they ever had before in evaluating these securities. I think there is a lot more to be done in terms of the alignment of interests. One of the reasons why issuance has been so sluggish is that these problems haven't been resolved, although there are a lot of people working on it.

What needs to happen to bring it back to a functional degree?

You need more standardization. You have one set of standard deal documents, so investors aren't reading through 900 pages of documentation on a single deal and worry that some smart law firm built something into page 287 that they missed. I think the introduction of a deal agent who looks out for investors is really important. You need improvements in transparency, and improvements in servicing structure, so you need to know what kind of modification was done on their loans. Right now the servicing process is totally nonstandardized and nontransparent. 

Are you somewhat optimistic that private-label securities will come back to some degree?

I think when bank lending is less robust than it is now, it sort of forces it to come back. You have another dimension, which is the pricing can adjust. If I said to a bunch of investors, you can buy these AAA securities, it is going to be 200 basis points over agency securities, they would all be lined up to do it. If you have no alternative, it sort of serves as a kick to bring it back.