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The Return of Mortgage-Backed Securities: Private Banks Ready to Play Fannie Mae and Freddie Mac

Last Updated September 23, 2020 1:01 PM
Adam Scott
Last Updated September 23, 2020 1:01 PM

Despite the fact that mortgage-backed securities helped tank the economy during the financial crisis of 2007–2008, banks are once again getting more heavily involved with mortgage bonds after the Trump administration proposed privatizing and downsizing Fannie Mae and Freddie Mac earlier this month.

‘Mortgage-Backed Securities? Pick ‘Em Up!’

citigroup windstream bankruptcy
Citigroup is one of several Wall Street behemoths reviving its mortgage-backed security business. | Image: Shutterstock

According to a new report from The Wall Street Journal , major banks like Citigroup Inc., Goldman Sachs Group Inc., Wells Fargo Group, and JPMorgan Chase & Co are all restarting or growing their practice of packaging mortgages or collections of mortgages into asset-backed securities.

These actions are largely taking place because a reduced Fannie Mae and Freddie Mac throw the door wide open for private banks to step into the state-sponsored mortgage behemoths’ shoes and take over the packaging and selling of mortgages.

Need Moar Yields!

With various economists calling for another global economic recession in the near-term, jumping back aboard the mortgage-backed securities bandwagon might not seem like the wisest idea.

Indeed, the market for said investments all but disappeared following the economic crisis in 2008.

However, investors are currently hunting for profits in an economy of low rates — and appear willing to dismiss the role mortgage bonds played in the 2008 financial crisis.

Mortgage Bonds: Risky Business

The most problematic aspect of private banks’ mortgage bonds is the fact that they are not protected by government backing.

Whereas Fannie Mae and Freddie Mac have Uncle Sam taking on the risks associated with default, mortgage-backed securities from banks are inherently higher risk.

Because of this, a lot of banks have steered clear of the risky asset-backed securities in the post-2008 world — but the demand for higher yields and willingness to take on more risk may trump historical lessons.

Should We Be Worried?

housing market data
The latest housing trends paint a bleak picture of U.S. residential real estate. | Image: Shutterstock

It may not be time to sound the alarm on the mortgage bond market — at least, not yet.

The Wall Street Journal report claims that Citigroup sealed a deal last month in which it bought 932 mortgages from Impac Mortgage Holdings Inc. — a nonbank lender — and backed $350 million worth of mortgage bonds with the purchase.

Still, the market for mortgage-backed securities is still downright minuscule compared to the massive derivative-inflated bubble that tanked the global economy upon its implosion. Only a hair over 2% of mortgages went into private bonds in the first half of 2019, compared to 41% in 2005.

Nevertheless, any time the market for mortgage bonds is increasing alongside warnings of an impending economic recession, there are questions to be asked. With interest rates from central banks around the world decreasing or going negative, unemployment rates hitting pre-recession lows as a potential leading indicator, and the inverted yield curve flashing code red on every mainstream news outlet, throwing more mortgage-backed securities into the mix may be even more cause for concern.