Financial Markets and Institutions (2-downloads)

mortgage pass-through, a security that has the borrower’s mortgage payments pass

through the trustee before being disbursed to the investors in the mortgage pass-

through. If borrowers prepay their loans, investors receive more principal than

expected. For example, investors may buy mortgage-backed securities on which

the average interest rate is 6%. If interest rates fall and borrowers refinance at lower

rates, the securities will pay off early. The possibility that mortgages will prepay

and force investors to seek alternative investments, usually with lower returns, is

called prepayment risk.

As is evident in Figure 14.3, the dollar volume of outstanding mortgage pools

has increased steadily since 1984. The reason that mortgage pools have become

so popular is that they permit the creation of new securities (like mortgage pass-

throughs) that make investing in mortgage loans much more efficient. For exam-

ple, an institutional investor can invest in one large mortgage pass-through

secured by a mortgage pool rather than investing in many small and dissimilar

mortgage contracts.

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Chapter 14 The Mortgage Markets

337

Funds in

Mortgage Pools

($ billions)

0

1,000

2,000

1995

1993

1991

1989

1987

1985

3,000

4,000

5,000

6,000

8,000

7,000

1999

1997

2001

2003

2005

2007

2009

F I G U R E   1 4 . 3

Value of Mortgage Principal Held in Mortgage Pools, 1984–2010

Source: Federal Reserve Bulletin, various issues, Table 1.54, Line 55.

Types of Pass-Through Securities

There are several types of mortgage pass-through securities: GNMA pass-throughs,

FHLMC pass-throughs, and private pass-throughs.

Government National Mortgage Association (GNMA) Pass-Throughs

Ginnie

Mae began guaranteeing pass-through securities in 1968. Since then, the popular-

ity of these instruments has increased dramatically.

A variety of financial intermediaries, including commercial banks and mortgage

companies, originate Ginnie Mae mortgages. Ginnie Mae aggregates these mortgages

into a pool and issues pass-through securities that are collateralized by the interest

and principal payments from the mortgages. Ginnie Mae also guarantees the pass-

through securities against default. The usual minimum denomination for pass-

throughs is $25,000. The minimum pool size is $1 million. One pool may back up many

pass-through securities.

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338

Part 5 Financial Markets

Federal Home Loan Mortgage Corporation (FHLMC) Pass-Throughs

Freddie

Mac was created to assist savings and loan associations, which are not eligible to orig-

inate Ginnie Mae–guaranteed loans. Freddie Mac purchases mortgages for its own

account and also issues pass-through securities similar to those issued by Ginnie Mae.

Pass-through securities issued by Freddie Mac are called