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CHAPTER 5
SECONDARY MORTGAGE MARKET
OBJECTIVES OF CHAPTER:
Upon successful completion of this chapter, students should be able to:
Distinguish between the primary and secondary mortgage market.
Describe the economic functions of the secondary mortgage market.
Understand the similarities and differences in different types of residential
mortgage-backed securities issued in the secondary market.
Identify the roles and activities of the major players in the secondary
mortgage market.
Summarize the mortgage purchase programs used by each of these
secondary market institutions and how they generate income for each party
involved.
Explain the trends that evolved in secondary market activity in the past
twenty years.
Understand the secondary mortgage market dynamics that occurred in the
recent mortgage crisis.
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Discuss the differences between Fannie and
Freddie.
How do their products differ?
How would a bank or investor choose who to
sell their loans or servicing to?
How you think the government will restructure
Fannie and Freddie? What impact might this
have on the industry and the country?
What would you suggest to the government,
should it dissolve the entities, make them 100%
government controlled, a combination of both,
or something else?
What caused Fannie and Freddie to end up in
receivership?
What role has private investors played in the
secondary market? What role should it play in
the future and why?
I. Introduction
II. Primary and Secondary markets
III. Economic Functions of the Secondary Market
A. Provide liquidity
B. Moderate cyclical flow of mortgage capital
C. Assist flow of capital from surplus to deficit
areas
D. Decreases the geographical spread in interest
rates and allows for portfolio diversification
IV. Mortgage Backed Securities (MBSs)
A. Why Were Nontraditional Investors Afraid
of Mortgages?
B. How Successful Have MBS’ Been?
V. Government National Mortgage Association (Ginnie
Mae)
A. Types of Ginnie Mae MBSs
B. Conventional MBS’s
C. Issuers of Conventional MBSs
D. Private Issuers of MBSs
E. Conceptual Issuers of MBSs
F. Importance of MBS Today
VI. Participants in the Secondary Market
A. Overview of the major participants
1. Federal Government Participants
Teaching Tips
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Name a few of the financial institutions active in the
primary market. List a few active in the secondary market.
How does the secondary market impact the industry an d
the economy?
Discuss how the MBS’s have or have not been a success
for the industry as a whole.
VII. The Government-Sponsored Enterprises: Fannie Mae
and Freddie Mac
VIII. Federal National Mortgage Association (Fannie
Mae)
A. Fannie Mae’s Beginnings and Separation from
Ginnie Mae
B. Federal Home Loan Mortgage Corporation
(Freddie Mac)
1. Historical Development
2. Participation program
3. Source of financing
4. Participation Certificates (PCs)
5. Guaranteed Mortgage Certificates
(GMCs)
C. Secondary Market Operations
D. How Fannie Mae and Freddie Mac
Finance Their Operations
E. Financing Mortgage Purchases
F. Fannie and Freddie’s Earnings
1. Net interest income /trust
management income
2. Guaranty fees
3. Fee Income
G. Competition between the Major Players
H. The Federal Home Loan Banks
IX. Ginnie Mae
A. GSE Regulation
X. Private Secondary Mortgage Market
XI. Residential Lending and the Secondary
Mortgage Markets
A. 1990s: Period of Growth for the
Secondary Market
B. Mega Servicers and Mega
Originators
C. 2000-2010: Part One-A period of
Expansion
D. 2000-2010: Part Two-Rapid
Decline
E. 2008: Crisis in the Secondary
Market
F. Fraud in the Secondary Market
XII. Post-Crisis Issues in the Secondary
Mortgage Market
A. The Dodd-Frank Wall Street
Reform and Consumer Protection Act
B. New Beginnings
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SUGGESTED TRUE/FALSE QUIZ
1. Typically in the last twenty years
40-60 percent of each year’s
originations are purchased by the
secondary mortgage market.
2. Both Fannie Mae and Freddie Mac
are now private corporations.
3. Fannie Mae and Freddie Mac
combined hold in portfolio about
50 percent of all outstanding U.S.
residential debt.
4. Fannie Mae averages about 50
percent more loans purchased each year than
Freddie.
4. Ginnie Mae was once a part of
Freddie Mac.
5. Fannie Mae purchases all types of single-family mortgages loans but
never multi-family.
In what ways has the growth of the secondary mortgage
market improved the industry and in what ways has it hurt
the industry? What is the impact on consumers?
The Dodd-Frank Act put many restrictions on the way the
secondary market can do business. What further
restrictions, if any, do you think we will see?
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6. According to the most recent statistics nearly one-third of loans
purchased by Fannie Mae had credit enhancements.
7. Freddie Mac was originally formed to serve members of the Federal
Reserve System.
8. Recourse can be defined as the contingent liability that a seller of a
mortgage loan has to repurchase the loan if the sale breaches on one of
the warranties the seller made.
9. A mortgage-backed security is a capital market security.
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SUGGESTED QUIZ (Use instead of multiple choice questions)
Directions Each of the following statements describes some aspect of the Federal
National Mortgage Association (FNMA), the Government National Mortgage
Association (GNMA), or the Federal Home Loan Mortgage Corporation
(FHLMC). Fill in the initials of the appropriate organization(s) in the space to the
right of each statement.
1. It is the largest single owner of residential mortgage debt.
2. It guarantees timely payment of principal and interest on securities
backed by FHA/VA loans.
3. It purchases FHA-insured, VA-guaranteed and conventional mortgages.
4. They retain many of the mortgages it purchases.
5. It was originally created for the use of the members of the F
7. It sells Mortgage Participation Certificates to thrifts and Guaranteed
Mortgage Certificates to bank trusts and pension funds.
8. They are in receivership by the government.
9. It is a part of HUD and is funded through the federal budget.
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SUGGESTED SHORT ESSAY QUESTIONS
1. Explain the difference between the primary and secondary mortgage
markets.
ANSWER: The primary mortgage market consists of lenders originating
mortgages and extending the funds directly to the borrower. The secondary
2. What are the benefits of uniform documentation to lenders and investors in
the secondary mortgage market? What secondary market business strategies
and trends started evolving in the 1990s and continue to define the market
today?
ANSWER: Lenders that use uniform documents at the time of origination
are assured that the documentation of loans will allow the loans to be
saleable in the future assuming all other features are acceptable to investors.
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3. Discuss the basic reason why MBS were reintroduced in the late 1960s. Why
were they accepted so well this time by investors?
ANSWER: The basic concept behind MBS was to provide more funds for
housing. Traditional lenders no longer had sufficient funds to provide for the
ANSWERS TO ORAL DISCUSSION POINTS
The discussion points at the end of each chapter are intended for oral
discussion in class. Suggested answers/points to emphasize for the questions
are found below.
1. What economic functions are performed by the secondary mortgage market?
ANSWER: (1) Provides liquidity. The secondary market is an accessible
market for investors who need funds and must liquidate their purchases. (2)
Moderates the cyclical flow of mortgage capital. Secondary market
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2. Identify the major players in the secondary market and their specific roles.
ANSWER: The players are Fannie Mae, Freddie Mac, Federal Home Loan
Banks and Ginnie Mae. The first three purchase mortgage loans although
3. What types of mortgage loans will Fannie Mae and Freddie Mac buy?
ANSWER: Basically all types of residential mortgage debt including
4. What factors helped cause the secondary mortgage market crisis in 2008?
ANSWER: Two large investment banks heavily involved in the secondary
mortgage market failed, along with several large insurance companies,
causing private investment in the secondary market to end abruptly. Fannie
5. What are “credit enhancements”? Why is it important to today’s market?
ANSWER: Both secondary mortgage market investors are required by their
charter from the federal government to obtain mortgage insurance on all
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mortgage loans if the loan-to-value (LTV) ratio at the time of purchase is
greater than 80 percent. In the past this meant mortgage insurance or
6. What does “recourse” mean? How can a lender avoid this risk?
ANSWER: Recourse can be defined, as the contingent liability a seller of a
7. What are mortgage-backed securities? Why are they so important?
ANSWER: MBS investors now constitute the largest classification of
8. What are the important differences between GSE-issued and privately-issued
MBSs?
ANSWER Private issue MBSs developed as a secondary mortgage market
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