Mortgage-Backed Securities And What They Mean For The Market

Federal Mational Mortgage Assctn Fnni Me FNMA on Friday reported that the government-sponsored enterprise (GSE) issued $14.4 billion of multifamily mortgage-backed securities (MBS) in Q4 of 2016. That number brings Fannie Mae's total for the year to $55 billion of total multifamily MBS.

Investors may remember MBS as the worthless trading vehicles that led to the near collapse of the U.S. financial system during the Great Recession of 2008-2009. With that in mind, investors should certainly generally be leery of the MBS market getting out of control once again.

However, while $55 billion in MBS may seem like a large number, multifamily MBS are just the tip of the iceberg. GSEs Fannie Mae, Federal Home Loan Mortgage Corp FMCC and Government National Mortgage Association issued more than $1.5 trillion in MBS combined in 2016, including single-family MBS.

Although that may be a scary number, the key danger in MBS issuance isn't quantity -- it's quality. MBS are simply a collection of mortgage loans that are pooled together for diversification purposes and then sold to investors. MBS can be a solid, responsible source of interest income for investors. Of course, the MBS is only as good as the quality of its underlying mortgages.

The mortgages themselves are like the ingredients of a cake. Solid mortgages make a healthy pool and a delicious MBS for investors. However, during the mortgage bubble, banks were baking cakes with rotten ingredients. The MBS market was flooded with subprime mortgages made to borrowers with poor credit and high default risk. When the defaults started piling up, these MBS became worthless.

Today, the mortgage lending market is much more regulated and legislation such as the Dodd-Frank Act keeps mortgage lenders and banks on a short leash. However, President Donald Trump has pledged to let the financial community off of the leash in the interest of economic growth.

Most Americans that lived through the mortgage crisis would be happy to never hear about an MBS ever again. However, with total MBS issuance up 17.7 percent in 2016 and a new president who has made financial deregulation a centerpiece of his campaign, it may only be a matter of time before lenders make a push for a return to the subprime mortgage “glory days.”