Friday, August 26, 2005

Mortgage Securitization and The Housing Boom

Wednesday's Wall Street Journal has a very interesting article titled "Housing-Bubble Talk Doesn't Scare Off Foreigners". It shows how the phenomena of securitization has changed the mortgage market. For the uninitiated, "securitization" is the process whereby mortgage loans are pooled and then used to back securities that are sold in the open market. It benefits all the players in the mortgage market- lenders, borrowers, and fixed-income investors.

These benefits occur because securitization allows lenders to reallocate risk to other parties (fixed income investors) that have a comparative advantage on bearing (or alternately a greater preference for) it. Since the lenders no longer have to keep the loans in their portfolio, they are willing to lend to borrowers with less pristine credit. As an example of this trend:

...Strong investor interest has also made loans available to borrowers with poor credit and many other people who might otherwise have trouble getting a mortgage. Subprime loans included in mortgage securities totaled $401.5 billion last year, nearly double the total for 2003, according to Standard & Poor's. Meanwhile, loans with less than full documentation of the borrower's income and assets accounted for 70% of mortgage securities rated by Standard & Poor's in this year's first half, double the level recorded in 2000.
As a result, interest rates are lower all along the risk spectrum. Finally, investors willing to bear the risk (in this case foreign investors) have more investment options.

Click here for the whole article (note: online subscription required).

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