BNA INSIGHTS: Can the Private Market Return to Home Lending?

This article originally appeared in Bloomberg Government. Click here to read the full article.

By Ike Brannon and Mark Calabria

When a family buys a home in the United States, they typically finance the purchase by obtaining a loan at a local bank or mortgage broker, which will take that 30-year promise of monthly payments and sell it to Fannie Mae or Freddie Mac. They will combine that mortgage with other mortgages, guarantee the payments, tack on a little something for its assumption of risk and then sell the resulting security in the market.

The securitization of mortgages is a way for the banks that issue them to divest itself of much of the risk inherent from such a loan. For instance, Hometown Community Bank in the small town of Morton, Ill., is likely to only make home loans within the environs of the town of Morton and the surrounding area. Because it knows the town well, it can fairly price the risk premium for mortgages in the town, but it cannot easily avoid the risk it faces if the local economy takes a turn for the worse, an event that would no doubt bankrupt many of its clients and hurt the value of the mortgages it held. By selling the mortgages to a third party it insulates itself from the risk of a localized economic catastrophe. If it uses the money from the sales of its mortgages to buy a mortgage-backed security it will have merely traded one type of risk for another, of course.

This article originally appeared in Bloomberg Government. Click here to read the full article.