Future housing demands and sources of mortgage money

Federal Home Loan Bank Board Journal, April, 1984 by Alan R. Winger

The Mortgage-Backed Security Model. This model assumes the mortgage-backed security comes to totally dominate the market. Most mortgage loans made are placed in pools which back up security issues that are sold to a wide range of investors. Many different types of loans are made and combined into these pools. Heterogeneity causes no problems in the nationwide distribution of the mortgage securities. The problem of risk evaluation when the pool is composed of heterogeneous mortgages is resolved through the application of insurance techniques that also foster the development of pooling techniques that better control the risk. Scale factors in this kind of operation lead to a mortgage market that is dominated by a small number of relatively large firms.

The Hybrid Model. The hybrid model is a combination of the other three. It assumes that thrifts continue to make mortgage loans for their own portfolios on the basis of funds they accumulate through savings deposits and borrowings from Federal Home Loan Banks. It also assumes further growht in the secondary market and a standardization of the mortgages involved in secondary market transactions. Some of the firms operating in this market grow quite large and deal with relatively few mortgage forms. Limitations on the type of mortgage loans made for sale in this market lead to a growth in the number of locally owned firms that make only special types of mortgage loans. Some of these are savings and loans that still accumulate deposits and borrow from Federal Home Loan Banks. The mortgage market is not totally dominated by either of these two groups, however. Mortgage-backed securities market experiments with, and achieves some success in, working with pools of heterogeneous mortgages, applying insurance techniques to deal with risk evaluation problems. The mortgage market does not become one great big mortgage-backed security, but the MBS market remains and grows in importance. What Will It Be?

While no one really knows what the future shape and form of the mortgage market will be, if change is evolutionary rather than revolutionary, the author believes the hybrid model should prevail. The secondary mortgage market and mortgage-backed securities market will expand further, and one important aspect of this expansion is likely to be the growth and development of a number of very large mortgage lending firms that operate nationwide. This development, however, will not preclude locally owned firms from making mortgage loans in local markets. Some of these loans will be very specialized; others will be more conventional, made on the basis of locally generated funds.

In a deregulated setting, a market with such diversity should evolve without difficulty, providing all of the funds residential mortgage borrowers want at a price (interes rate). That price is likely to be relatively high, however, if the economy does not perform well. Indeed, relatively high interest rates are one of the reasons why housing demand is expected to sustain a starts level of only 1.7 million units per year.