The news on the mortgage front seems scary. Merrill Lynch just lost $250 million, largely because its chief trader guessed wrong in the mortgage-backed securities market.
And that trader was not alone. Many small investors who bought Government National Mortgage Assn. mortgage pass-through certificates in the past year are worried today because their 8.5% to 9% Ginnie Maes are trading below what they paid for them.
Such investors, who may not have thought they were risking principal, now wonder if mortgage securities are safe to hold.
Finally, interest rates on home mortgages, which are now hooked into that big-time market, have jumped up sharply in the past few weeks--in some cases by as much as two percentage points. Interest rates on home mortgages, the safest, most stable credit in our system, never used to jump around like that.
So what's the story? Is the booming mortgage market, in which $600-billion worth of securities backed by residential mortgages now trade, some devilish new threat to the system?
Money Is Available
No. The villain, if there is one, is global instability in which all interest rates are shoved around by such powerful forces as international currency trading, the size of the U.S. trade and budget deficits and the whims of foreign investors.
The plain truth is, if we didn't have the mortgage securities market in a time of such interest rate uncertainty it would be harder for home buyers to get a mortgage at any price.
It is undoubtedly annoying to home buyers that they face interest rates of 10.25% and more today, when less than a month ago they might have locked in a fixed-rate loan at 9.5%. But at least mortgage money is available.
In the old days, banks and savings and loans would simply stop making mortgage loans in a period like the present because they were afraid to take the risk of making a 30-year loan at one rate when they might soon have to pay out a higher rate to attract deposits.
In fact, it was just such a situation that kicked off the real growth in mortgage securities in 1982, when S&Ls were in an unprofitable bind. There was nothing wrong with their mortgages, understand; their payments were coming in every month. The problem was they were collecting low interest on old mortgages while paying out higher interest for deposits.
So government-backed agencies such as the Federal National Mortgage Assn. (Fannie Mae) and the Federal Home Loan Mortgage Corp. (Freddie Mac), along with GNMA, came to their rescue by buying the old mortgages and bundling them into securities that insurance firms, pension funds and other institutions could invest in.
Provided a Way
The idea was an instant success. Such institutions had long recognized residential mortgages as prime credits, but had lacked an efficient way to invest in your mortgage and your neighbors'.
The certificates of Ginnie Mae and others, which pass through your mortgage payment minus collection costs and fees, allowed the institutions to take the long-term risk off the backs and balance sheets of the lending institutions and helped them to recycle mortgage money faster.
The business has grown enormously. Last year, $262 billion worth of mortgages, more than 66% of all mortgages written, were bundled into securities, according to Michael Youngblood of Salomon Bros., who does detailed research on the market.
Wall Street investment houses and banks such as Citicorp and Security Pacific now create their own mortgage certificates and back them with private insurance.
And the market has spawned variations. There are investments for institutions wanting a schedule of payments undisrupted by mortgage prepayments--the fact is that the average mortgage, even though written for 15 to 30 years, is paid off in seven.
And now there are ways for institutions to buy separate securities backed by either a mortgage pool's interest or principal. It was on one of those instruments, called Strips, that Merrill Lynch bet wrong and blew $250 million.
But you're not Merrill Lynch, and its problems don't affect your Ginnie Mae. If it is trading at a price below what you paid, don't be alarmed.
Be assured that, just as with a bond, the principal will be repaid over time. And if interest rates should decline again--a distinct possibility if calm is restored to the international economic system--your Ginnie Mae will rise in value. Meanwhile, you can be sure of continued interest payments.
As for mortgage interest rates, they may react more quickly these days to global conditions. But that doesn't mean they overreact. Mortgage rates have risen in the past month, but no faster than those of 10-year Treasury bonds.
There may be a lot of things to worry about in this changing world, but the U.S. mortgage system, happily, isn't one.