The secondary mortgage market is the market for the sale of securities or bonds collateralized by the value of mortgage loans. A mortgage lender, commercial bank, or specialized firm will group together many loans (from the "primary mortgage market"[1]) and sell grouped loans known as collateralized mortgage obligations (CMOs) or mortgage-backed securities (MBS) to investors such as pension funds, insurance companies and hedge funds.[2] Mortgage-backed securities were often combined into collateralized debt obligations (CDOs), which may include other types of debt obligations such as corporate loans.
The secondary mortgage market was intended to provide a new source of capital for the market when the traditional source in one market—such as a Savings and loan association (S&L) or "thrift" in the United States—was unable to. It also was hoped to be more efficient than the old localized market for funds which might have a shortage or surplus depending on the location.[3] In theory, the risk of default on individual loans was greatly reduced by this aggregation process, such that even high-risk individual loans could be treated as part of an AAA-risk (safest possible) investment.
On the other hand, mortgage securitization undid "the connection between borrowers and lenders", such that mortgage originators no longer had a direct incentive to make sure the borrower could pay the loan. While historically in the US, fewer than 2% of people lost their homes to foreclosure; rates were far higher during the Subprime mortgage crisis.[4] Delinquencies, defaults, and decreased real estate values could make CDOs difficult to evaluate. This happened to BNP Paribas in August, 2007, causing the central banks to intervene with liquidity.
- ^ Definition of 'Primary Mortgage Market' "The market where borrowers and mortgage originators come together to negotiate terms and effectuate mortgage transaction ..."
- ^ Investopedia 'Primary Mortgage Market'
- ^ All the Devils Are Here, MacLean and Nocera,p.5
- ^ All the Devils Are Here, MacLean and Nocera, p.19