Mortgage Marketing
How securitisation methods on Mortgage markets help to pass on credit risks?
Well, it does help to reduce the relative frequency of default, though I don’t think it does much to reduce to total magnitude of risk. Let me explain…
In the old days, a bank would finance the sale of a property and would then hold the purchasers debt until it was repaid. If a purchaser were to default, that bank alone would lose money. Conversely, as the mortgage was paid back with interest, that bank alone would make money.
Today, banks still finance the sale of real estate; however, rather than holding the purchasers debt, they sell it to a third party. In doing this, they earn a smaller return than they would by holding the loan to maturity; however, they also greatly reduce the risk of default. The third party, who is buying tons of mortgage debt from lending institutions, then packages all of these mortgages into an asset known as a Collateralized Debt Obligation (CDO).
A CDO is basically like a bond of aggregated mortgages. There are statistical methods for reducing risk based on how a CDO is structured. For example, mortgages from multiple geographic regions may be packaged into a single CDO. Case in point: During the credit crisis, California experienced significantly higher rates of mortgage default than the rest of the country. If a CDO was comprised entirely of California mortgages, it would lose significantly more value compared to a CDO comprised of California, New York, Texas, and Pennsylvania properties. Basically, exposure is diversified by the way a CDO is structured.
Based on the credit crisis, I’d say that local risk is reduced by the securitization of mortgage debt; however, I think the total systemic risk is unchanged, or perhaps even greater because now a mortgage is leveraged many times through the use of derivatives such as Credit Default Swaps and synthetic CDOs.
Mortgage Referral Marketing for Loan Officers and Managers
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