Financial Markets and Institutions (2-downloads)

accounts. Reserve accounts are established for most mortgage loans to permit the

lender to make tax and insurance payments for the borrower. Lenders prefer to make

these payments because they protect the security of the loan. Loan-servicing agents

usually earn 0.5% per year of the total loan amount for their efforts.

In summary, there are three distinct elements to most mortgage loans:

1. The originator packages the loan for an investor.

2. The investor holds the loan.

3. The servicing agent handles the paperwork.

One, two, or three different intermediaries may provide these functions for any

particular loan.

Mortgage loans are increasingly obtained from the Web. The E-Finance box dis-

cusses this new source of mortgage loans.

Commercial Banks

26%

Savings and Loans

5%

Mortgage Pools and Trusts

53%

Federal Agencies and Other

14%

Life Insurance Companies

2%

F I G U R E   1 4 . 2

Share of the Mortgage Market Held by Major Mortgage-

Lending Institutions

Source: Federal Reserve Bulletin, April 2010, Table 1.54.

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Chapter 14 The Mortgage Markets

335

Secondary Mortgage Market

The federal government founded the secondary market for mortgages. As we noted

earlier, the mortgage market had all but collapsed during the Great Depression. To

help spur the nation’s economic activity, the government established several agen-

cies to buy mortgages. The Federal National Mortgage Association (Fannie Mae) was

set up to buy mortgages from thrifts so that these institutions could make more mort-

gage loans. This agency would fund these purchases by selling bonds to the public.

At about the same time, the Federal Housing Administration was established

to insure certain mortgage contracts. This made it easier to sell the mortgages

because the buyer did not have to be concerned with the borrower’s credit history

or the value of the collateral. A similar insurance program was set up through the

Veterans Administration to insure loans to veterans after World War II.

One advantage of the insured loans was that they were required to be written

on a standard loan contract. This standardization was an important factor in the

growth of the secondary market for mortgages.

As the secondary market for mortgage contracts took shape, a new interme-

diary, the mortgage bank, emerged. Because this firm did not accept deposits, it

was able to open offices across the country. The mortgage bank originated the

loans, funding them initially with its own capital. After a group of similar loans were

made, they would be bundled and sold, either to one of the federal agencies or

to an insurance or pension fund. There were several advantages to the mortgage

banks. Because of their size, they were able to capture economies of scale in loan

E - F I N A N C E