CFA Institute: Investors Would Buy MBS Minus Guarantees with Better Underwriting Standards

Categories: Americas, Systemic Risk, US Regulatory Reform
Mortgage

Sometime over the next fortnight, the U.S. Senate Banking Committee is expected to release its proposals for mortgage and MBS market reforms. It is an issue that the Dodd-Frank Act ignored in 2010 but one whose systemic implications have been raised by many CFA Institute members. But it is the investment sector whose decisions on whether to buy securities backed by these mortgage loans that ultimately will determine the success or failure of this reform effort.

To determine how interested the investment sector is in MBS, CFA Institute invited members engaged in fixed-income investing to give their views on the market. The investors were asked about whether they currently invest in the market, their likelihood of investing in MBS in the future, the importance of a federal guarantee in their MBS investment decisions, and what would persuade them to invest without a federal guarantee.

The survey, taken in mid-November 2013, found overwhelming willingness (72%) on the part of these fixed-income investors who responded to the survey to buy MBS without the benefit of federal guarantees — so long as they had assurances about the quality of underwriting and transparent data to verify those underwriting standards. Likewise, 71% of survey respondents indicated that higher yields were needed to overcome the risks they believe they are assuming when putting their clients’ funds at risk in these securities. Failing these reforms, a small majority (56%) said federal guarantees were important, even though 81% recognized those guarantees distort the market.

We have been using these survey results in our advocacy efforts in Washington D.C. Specifically, they have given members of Congress and their staffs the views of investors in this market, a perspective that they really need to hear.


Photo credit: iStockphoto.com/Kuzma

3 comments on “CFA Institute: Investors Would Buy MBS Minus Guarantees with Better Underwriting Standards

  1. Orest Monokandilos, CFA said:

    Maybe there should be a neutral agency pricing Credit Default Swaps (CDS) on every MBS with at least one page detailed standardized explanation on the price. Every issuer should provide a standard block of information to support/explain the underwriting on each MBS…

    • Albert Jaffarian said:

      Perhaps MSL should be offered separately from a guarantee or CDS. The risk, pricing and value of portfolio itself would correlate with the underwriting standards and portfolio characteristics that would be indicative of probability of default, extent of loss given a default, prepayment risk, sensitivity to changes in interest rates, unemployment, etc. There has to be enough information to make analysis of the expected cash flows work. If a buyer needs a guarantee or CDS then the risk, pricing and value of that instrument could be evaluated separately. At the end of the day the money has to come from somewhere, what goes around comes around and oh – don’t forget you can’t have your cake and eat it too.

      • Jim Allen, CFA said:

        Absolutely agree that the market needs a mechanism – yours or some alternative – to enable investors to assess the risks and determine a price they are willing to pay. We would suggest that skin in game from loan originators and securitizers would provide a significant credit enhancement, thus improving pricing.

        The problem is that the big banks don’t want the latter, and the politicians don’t want the former. The politicians don’t want too much disclosure because it would highlight those markets (i.e., theirs) where loan quality is poor, while the banks don’t want skin in the game because it would reduce the leveragability of these assets. And nobody wants to incorporate risk into the price of mortgage credit because of the potential costs.

        Nothing will happen this year, and Johnson-Crapo will likely provide the starting point for the Senate in the next Congress, regardless of who is in control. The PATH Act will likely be the starting point for mortgage reform in the House, as well. So mortgage reform in the next Congress will look awfully similar to what we’ve seen in this last one, with likely similar results – i.e., the shaky status quo.

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