12 / THE SECONDARY MORTGAGE AND TRUST DEED MARKETS

The following two chapters answer the question What happens after the loan has been made? beginning with this chapter on the secondary loan market. With an overall mortgage debt in this country of over four trillion dollars, it is important to discover how this much money is handled by all of the participants involved. On the one hand, we have millions of borrowers executing agreements to pay loans and sending payments to companies designated as collectors. On the other hand, we have lenders receiving these payments, reducing the amount of debt in a regular manner over time, with a constant inflow of new loans to replace those which are paid in full.

In the center of this ebb and flow of vast sums of money are the secondary mortgage and trust deed market participants, who, in moves designed to keep these money flows in balance, buy, sell and service the individual securities. In doing so, they redistribute funds from money-rich areas of our country to money-poor areas, offsetting, to a great degree, the difficulties caused by a mostly uncontrolled cyclical real estate market.

This chapter examines the activities of Fannie Mae, Ginnie Mae and Freddie Mac, plus the private collateralization conduits. Most of the real estate loans made in today's market are sold to these secondary market operators. The monies paid for these individual loans comes from the millions of investors who participate in the action by buying shares in mortgage pools. Thus, the investors continue to provide the monies necessary to fund the enormous realty debt.

Besides the information in this chapter about the activities of FNMA, GNMA and FHLMC, there is a movement into securitization at lower levels of the financial markets. Individual lenders who make a substantial number of loans are pooling them rather than selling them, and then sell interests in these pools to investors, as described under REMICs. Since this may well be the shape of our future realty finance markets, it would enhance the presentation of the material in this chapter to invite a participant in these pools to discuss them with the students.

Learning Objectives

Upon completion of this chapter, the student should be able to:

1. Define the secondary mortgage markets;
2. Recognize the influences of the secondary markets in facilitating the national redistribution of funds for real estate finance and providing a constant source of funds for local lenders who wish to roll their loans over;
3. Understand the purpose and operations of the FNMA, GNMA and FHLMC;
4. Define the FNMA-GNMA tandem plan;
5. Describe mortgage-backed securities and how they can be pooled for sale to investors as REMICs.

I. The Secondary Mortgage Market

A. Originators of new loans are called primary lenders

1. Banks

2. Thrifts

3. Life insurance companies

4. Pension funds

5. Mortgage bankers

6. Mortgage brokers

B. Most loans created by primary lenders are sold in the secondary market

1. Lenders acquire money for new loans

2. Many keep loan servicing responsibilities

3. Provide sources of funds to all areas of the country

4. Escape risks of holding long term loans

II. The Federal National Mortgage Association (FNMA)

A. Originally a government agency

1. Created to buy FHA-insured loans issued in the Depression

2. Bought loans at par to stimulate economic recovery

B. Charter of 1954

C. Housing and Urban Development Act of 1968

D. Municipal Mortgage Enhancement (Munie Mae)

III. The Government National Mortgage Association (GNMA)

A. Under the Department of Housing and Urban Development (HUD)

B. Securities pools

a. Homogenous loans in one program

b. Nonhomogeneous loans in another program

2. Distribution of earnings to investors

3. Investors charged a premium for GNMA guarantees

C. Tandem plan

1. Monetary assistance in tight money cycles

2. Funds available for high risk loans

3. GNMA purchases loans at par from FNMA

IV. The Federal Home Loan Mortgage Corporation (FHLMC)

A. Created in 1970 to offset credit crunch for the savings associations

1. Purchased conventional loans from participating thrift organizations

2. Provided funds to offset financial crisis

B. Reorganized in 1989 into private corporation

1. Expanded its secondary market participation

2. Could now purchase or sell any qualified security

C. FHLMC and FNMA mortgage loan limits

V. The Real Estate Mortgage Investment Conduit (REMIC)

A. Concept created in the Tax Reform Act of 1986

1. Allows private companies to securitize

2. Allows REMICs to be exempt from income taxes

B. REMIC flexibility

1. Allows trading with foreign investors

2. Allows creation of multiclass securities

a. Short-term tranches

b. Long-term tranches

c. A tranch is a portion of a multiclass security