Finance_03 Instructor Materials.docx

3. The Primary and Secondary Markets Learning Objectives After completing this lesson, students should be able to... Describe how lending takes place in the primary market Discuss the effect of real estate cycles on real estate markets Explain the relationship between the primary and secondary markets, including how mortgage funds flow from investors to lenders to home buyers List the major secondary market entities and explain the concept of a government-sponsored enterprise (GSE) Explain mortgage-backed securities and their function in the secondary market Discuss the importance of underwriting guidelines established by GSEs Give examples of the benefits of GSEs and their efforts to increase the availability of mortgage funds Summarize the most recent developments with the GSEs in the wake of the 2007 mortgage and financial crisis Suggested Lesson Plan 1. Give students Exercise 3.1 to review the previous chapter, “Federal Fiscal and Monetary Policy.” 2. Provide a brief overview of Chapter 3, “The Primary and Secondary Markets,” and review the learning objectives for the chapter. 3. Present lesson content: The Two Mortgage Markets Primary Market – Local financing – Real estate cycles – Addressing the problem of cycles EXERCISE 3.2 The primary market and real estate cycles Secondary Market – Buying and selling loans – Mortgage-backed securities – Effects of the secondary market EXERCISE 3.3 Selling loans on the secondary market Fannie Mae and Freddie Mac – Creation of the entities – GSE status – Standardized documents and underwriting – The GSEs and the economic crisis 4. End lesson with Chapter 3 Quiz. Chapter 3 Outline: The Primary and Secondary Markets I. The Two Mortgage Markets A. Primary market: financial arena in which home buyers apply for loans and lenders originate them 1. Traditionally a local market, made up of lending institutions 2. Problem: Local market is subject to real estate cycles a. When business is booming, local community’s demand for mortgage funds may exceed local lenders’ supply b. In an economic slump, local lenders’ supply of mortgage funds may exceed local demand c. Secondary market eases problem of real estate cycles EXERCISE 3.2 The primary market and real estate cycles B. Secondary market: national market in which mortgage loans are bought and sold 1. Mortgage loans can be sold like other types of investments a. Present value of loan based on yield currently available on investments of similar quality (same degree of risk) b. Lender may sell loans to other lenders or investors in another part of the country, or to a secondary market entity 2. Mortgage-backed securities a. Government-sponsored entity buys many mortgages and pools them together; pool is pledged as collateral for the securities b. Investors who buy mortgage-backed securities receive monthly payments of principal and interest from entity as pooled loans are repaid 3. Effects of the secondary market a. Makes funds available for mortgage loans nationwide b. Promotes home ownership and real estate investment c. Moderates adverse effects of local real estate cycles d. Increases flow of mortgage funds i. GSE uses funds from sale of securities to buy more mortgage loans from primary market ii. Primary market lender uses funds from sale of loans to make more loans to borrowers EXERCISE 3.3 Selling loans on the secondary market II. Fannie Mae and Freddie Mac A. Creation of the entities 1. Fannie Mae (Federal National Mortgage Association) a. U.S. government created Fannie Mae in 1938 b. Original purpose: buying FHA-insured loans from lenders c. Reorganized as a private corporation in 1968, but remains a GSE now supervised by the Federal Housing Finance Agency (FHFA) d. When FNMA became a private corporation, Congress created a new wholly owned government corporation, the Government National Mortgage Association, or Ginnie Mae i. Ginnie Mae is an agency within HUD ii. Ginnie Mae guarantees securities backed by FHA and VA loans, but does not purchase loans or sell MBSs 2. Freddie Mac (Federal National Mortgage Corporation): GSE created in 1970 to help savings and loans by buying conventional loans B. GSE Status 1. Fannie Mae and Freddie Mac limited to residential mortgages and mortgage-backed securities 2. Required to meet annual affordable housing goals 3. Supervised by the FHFA C. MBS programs 1. First mortgage-backed securities program started by Ginnie Mae in 1970, backed by pools of FHA and VA loans 2. Fannie Mae and Freddie Mac soon followed, issuing MBSs backed by pools of conventional mortgages 3. Attractive to investors because MBSs were guaranteed by secondary market entity that issued them D. Standardized documents and underwriting 1. Loans sold to GSEs must meet their underwriting guidelines, which are standardized across the country 2. GSEs’ rules give MBS investors confidence in loan quality 3. Lenders are more willing to make specific types of loans once Fannie Mae and Freddie Mac have decided to purchase them 4. GSEs and subprime loans a. GSEs previously purchased only prime loans b. GSEs began to loosen underwriting standards and to purchase A-minus loans to compete in the market and meet affordable housing goals E. The GSEs and the Economic Crisis 1. Federal conservatorship a. In 2008, Congress put GSEs under regulation of the FHFA as part of a plan to address fallout from the subprime mortgage crisis b. Later that year, the FHFA took control of both GSEs and put them under federal conservatorship 2. Federal guaranty a. Previously, GSEs had guaranteed their MBSs, but the federal government had no legal obligation to back up those guaranties b. Under conservancy, the federal government now guarantees mortgage-backed securities issued by Fannie Mae and Freddie Mac Exercises EXERCISE 3.1 Review exercise To review Chapter 2, “Federal Fiscal and Monetary Policy,” have students indicate whether the following terms relate to monetary policy or to fiscal policy. 1. Open market operations 4. Federal deficit 2. Federal funds rate 5. Reserve requirements 3. Mortgage interest deductions Answers: 1. MONETARY POLICY. Through open market operations (buying and selling government securities), the Federal Reserve can directly affect the money supply by either putting money into circulation or taking it out. 2. MONETARY POLICY. The federal funds rate is one of two interest rates that the Federal Reserve influences as part of its monetary policy. 3. FISCAL POLICY. Tax deductions, such as the one for home mortgage interest, affect the government’s revenues. 4. FISCAL POLICY. Raising revenue, spending money, and managing debt (the federal deficit) are all part of the government’s fiscal policy. 5. MONETARY POLICY. Reserve requirements limit the amount of money in circulation by forcing banks to keep a certain percentage of deposits on hand. EXERCISE 3.2 The primary market and real estate cycles Read the following True/False questions aloud to students and have them jot their answers down on a piece of paper; discuss the answers together. 1. The primary market is where mortgage lenders make loans to home buyers. 2. At one time, the primary market was a national market, but that’s no longer the case. 3. Before the primary market was established, secondary market lenders were often severely affected by local real estate cycles. 4. When depositors withdraw their funds from savings accounts and put them into competing investments that offer higher returns, it’s called disintermediation. 5. Real estate cycles result from changes in the supply of and the demand for mortgage loan funds. Answers: 1. TRUE. Someone who wants to borrow money to finance the purchase of a home applies to a lender in the primary market. 2. FALSE. The primary market was originally strictly local, consisting of local lenders that used the savings deposits of members of the community to fund mortgage loans for the purchase of property in the community. Now there are many nationwide, regional, and online mortgage lenders. 3. FALSE. It was primary market lenders that were severely affected by local real estate cycles, a problem that development of the secondary market significantly alleviated. 4. TRUE. Disintermediation can reduce the supply of funds that local financial institutions have available for mortgage lending. 5. TRUE. Imbalances in the supply of and the demand for mortgage funds cause a local real estate market to go through active periods followed by slumps. These changes are called real estate cycles. EXERCISE 3.3 Selling loans on the secondary market Discussion Prompt: A home buyer obtains an adjustable-rate mortgage to finance her purchase. What factors will affect whether the lender can sell this mortgage on the secondary market? Once a loan is purchased by a GSE, what does the GSE do with it? What does a GSE usually do with money it earns from the sale of mortgage-backed securities? What does a primary market lender generally do with money it earns by selling loans on the secondary market? Analysis: It will be easiest to sell the loan if the borrower, the property, and the loan terms meet the underwriting guidelines set by the GSEs, Fannie Mae and Freddie Mac. (Fannie Mae and Freddie Mac may be willing to buy a loan that doesn’t follow the standard guidelines, but the lender will have to negotiate to arrange the sale.) If a loan is purchased by Fannie Mae or Freddie Mac, it will add it to a pool of other mortgage loans that meet the underwriting guidelines, issue mortgage-backed securities based on that pool, and then sell the securities to investors. A GSE usually takes the money it receives from the sale of mortgage-backed securities and uses it to buy more loans from primary market lenders. A primary market lender usually takes the money it receives from the sale of loans on the secondary market and uses it to make more loans to home buyers. Chapter 3 Quiz 1. Periodic changes in the level of activity in a local real estate market are called: A. disintermediation B. capital turnover C. real estate cycles D. appreciation 2. A GSE usually subtracts which of the following from a loan payment, before passing it along to the investor? A. Guaranty fee B. Origination fee C. Discount point D. Buydown 3. Mortgage-backed securities: A. are issued by lenders B. help provide funds for mortgage lending C. raise the cash that finances the federal deficit D. All of the above 4. All of the following statements are true except: A. GSEs were created by the federal government B. GSEs are owned by private stockholders C. GSEs are supervised by HUD D. GSEs are supervised by the FHFA 5. The only secondary market entity that does not purchase conventional loans is: A. FNMA B. Freddie Mac C. GNMA D. Federal National Mortgage Association 6. The return on a mortgage-backed security usually takes the form of: A. annual dividend payments B. monthly interest payments C. annual guaranty fees D. monthly principal and interest payments 7. The rules lenders apply when qualifying loan applicants are called: A. secondary market rules B. underwriting guidelines C. diversification D. uniform market standards 8. Which of the following is true of the secondary market? A. It promotes home ownership and investment B. It provides funds for home loans C. It stabilizes the primary market D. All of the above 9. The underwriting guidelines established by the GSEs: A. have a minimal impact on lending standards in the primary market B. have a significant impact on lending standards in the primary market C. provide lenders with sample forms and standards D. None of the above 10. When a lender keeps its own mortgage loan investment rather than selling it on the secondary market, this is known as a: A. mortgage guaranty B. portfolio loan C. security D. conventional loan 11. Mortgage-backed securities are attractive to investors because they: A. are more liquid than mortgages B. can be purchased in comparatively small denominations C. Both A) and B) D. Neither A) nor B) 12. Fannie Mae and Freddie Mac do all of the following except: A. issue mortgage-backed securities B. issue private-label securities C. help increase the availability of mortgage funds nationwide D. pool loans together for resale on the secondary market 13. All of the following statements are true, except: A. Fannie Mae and Freddie Mac are only allowed to invest in residential mortgage assets B. Ginnie Mae is a government-owned corporation C. Fannie Mae and Ginnie Mae purchase FHA and VA loans D. Ginnie Mae has a greater impact on the mortgage industry than Fannie Mae and Freddie Mac 14. In response to the mortgage and foreclosure crisis, the government: A. placed both GSEs into conservatorship B. created a new regulator for the GSEs C. assumed guaranty responsibility for MBSs issued by the GSEs D. All of the above 15. Freddie Mac’s original purpose was to: A. aid banks that were failing as a result of the Depression B. buy FHA and VA loans C. issue mortgage-backed securities based on non-conventional loans D. assist savings and loan associations that were hit by the 1969 recession Answer Key 1. C. Ups and downs in the level of activity in a local real estate market, where a boom is followed by a slump, are called real estate cycles. These can have a significant impact on the availability of funds for lending. 2. A. In exchange for the guaranty on a mortgage-backed security, the issuing GSE subtracts a guaranty fee before passing payments along to the investor. 3. B. The GSEs issue MBSs, as do some private companies; lenders do not. Treasury securities are sold to finance the deficit. 4. C. Although the GSEs were originally supervised by HUD, in 2008 the federal government created a new regulatory agency to supervise them, the Federal Housing Finance Agency or FHFA. 5. C. Both Fannie Mae and Freddie Mac are authorized to purchase FHA, VA, and conventional loans. Ginnie Mae is not. 6. D. An MBS investor receives monthly payments of principal and interest as borrowers repay the loans in the pool. 7. B. Underwriting guidelines are the rules applied when a loan applicant is being qualified by a lender. The GSEs have established their own underwriting guidelines. 8. D. The secondary market promotes home ownership and investment in real estate by making funds available for mortgage loans. It also moderates the adverse effects of real estate cycles, making the primary market more stable. 9. B. The underwriting guidelines set by the GSEs have had a tremendous impact on the primary market. Since the GSEs will not buy loans that do not follow the guidelines, lenders are motivated to make loans according to these standards. 10. B. If a lender keeps a mortgage as part of its own investments until the loan is repaid, the loan is known as a portfolio loan. 11. C. Mortgage-backed securities are considerably more liquid than mortgages and investors can purchase securities in comparatively small denominations. 12. B. Mortgage-backed securities are issued by Fannie Mae and Freddie Mac. Private-label securities are issued by private firms that buy and pool mortgage loans. 13. D. Because Fannie Mae and Freddie Mac can buy conventional loans in addition to FHA and VA loans, they have a greater impact on the mortgage industry than Ginnie Mae. 14. D. In 2008, the federal government implemented all of the activities listed, in an effort to stabilize the GSEs and prevent their failure. 15. D. The Federal Home Loan Mortgage Corporation was created to assist savings and loan associations that were hit hard by a recession in 1969 and 1970.

Finance_03 Instructor Materials.docx

Related

Transcript

Upgrade to continue