What is securitisation?

Securitisation is the process of transforming individual illiquid and non-tradable loans or mortgages in this case, into marketable securities.

This is performed by transferring these loans into a specially created entity or trustee called a Special Purpose Vehicle (SPV). The SPV then issues securities backed by the asset pool to the financial markets. In other words, securitisation is a form of financial intermediation. The securities issued by the trustee or the SPV are called Mortgage-Backed Securities (MBS).

The market for securitised assets is the largest in the world and the fastest-growing. The US has a deep, broad and active secondary market for mortgages, unlike most other loan types.

In large part, this is because the government is heavily involved in the single-family secondary mortgage market to promote securitisation. US securitised debt in 2006 stood at $8.6 trillion, when compared to Treasuries at $4.3 trillion while total outstanding US bond market debt is $27.4 trillion.

Historically, the growth of the mortgage market in the US is mainly due to government support and sponsorship with an objective of supporting socio-economic stability by promoting home ownership through accessible housing finance via the mortgage market.

Three agencies, either government-owned or government-sponsored, were historically created to be instrumental in the mortgage securitisation process. Informally they are known as Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).

For example, rather than provide direct financing for mortgages, Ginnie Mae, a government-owned agency, will guarantee payments on mortgage pools that are created by private pool organisers, providing that mortgages in the pool conform to its requirements.

By doing so, it reduced the transactions costs associated with credit risk assessment and provided its own credit rating to the pool.

Fannie Mae purchases packages of mortgages from banks and financial institutions. It finances these purchases by issuing its own securities, mainly MBSs. Even though it was privatised, it still benefits from an emergency line of credit from the US Treasury in extremis.

This line of credit and explicit government support contribute to investors' perception that FNMA is a government-sponsored entity. Indeed, the rating of Fannie Mae bonds is AAA.