In developed economies, a typical household has three dominant assets in its wealth portfolio: Cash, a Car, and a house. Interestingly, apart from the first, the latter two are usually financed real-asset purchases, which means the households do not enjoy the ultimate title to it. Nevertheless, they utilise them as any normal owner of the asset would do so. The Mortgage Market enables households to get on the property ladder. It helps businesses and firms get the necessary financing for buying buildings and other land assets to expand their business operations.
| Relationship Between the Mortgage Market and the Economy Mortgage Market activity is highly dependent on the interest rate set by the central banks and the general demand level in the country. For example, as of Q2-2023, the UK outstanding mortgage debt is £1,655.5Bn. Which is approximately £9.375Bn less than the expected amount. The biggest ever drop since 2007. This drop is due to an increase in interest rates from almost 0.25% to 5.25% and an increase in inflation. That has ultimately resulted in customers applying for mortgages and banks being more careful when granting loan applications. |
Mortgage Market as a Complex System
Mortgage Market refers to a conceptual construct where individuals, groups of individuals, and businesses source the money for their residential and commercial property needs. Ostensibly, it’s assumed that a mortgage is a bilateral agreement between a mortgage and the bank, and the property is pledged as collateral. Nonetheless, technically, it’s a flawed understanding of the entire process. Banks or other financial intermediaries purchase the IOU written by the mortgage holder. This IOU is a debt security that banks re-sell to the investors and then act as a middleman between the investors and mortgage holders. Banks collect cash (monthly mortgage payments), deduct their collection fees, and pay the remainder to the investors.
Therefore, the Mortgage Market is a complex system in which mortgage holders, financial institutions, and investors are tied to one rope. Therefore, the performance of one party affects the performance of the other party. For example, if the mortgage holders make payments on time and clear their debt, then the banks also can collect the cash and disburse it to the investor of Mortgage-Backed Securities. However, the default of one party leads to the default of the other two parties as well, subprime crisis is a good example to understand this phenomenon.
Understanding a Mortgage Agreement
A mortgage is a long-term loan secured by real estate (house or offices. Individuals, businesses, or governments can obtain long-term secured loans in the mortgage market.
Therefore, the instruments created by this are as follows:
- IOU notes by the mortgage holder, the person mortgaging a house. This note is a debt obligation like a bond and carries a fixed interest, maturity date, and frequency in which payments are to be made.
- The second instrument is a Mortgage-Backed security (MBS). This is resold to investors over the counter or through a trade exchange.
| Securitisation of Mortgage Agreement In capital markets, the instruments exchanged are usually standard and pre-issued by issuers such as firms, governments, and corporations. However, the mortgage market instruments are created to meet the needs of individual customers. Therefore, when the MBSs are created, they are also heavily customised to meet the needs of investors. This process is known as securitisation. Securitisation refers to the process whereby multiples (e.g., 1000s of) individual mortgages are bundled together and sold as security to the investors. This allows the originator of mortgage loans to transfer risk from their books to another investor. It also frees capital for the bank to make loans for new investors and enables them to continue helping people buy houses. |
References
- Campbell, J. Y. (2013). Mortgage market design. Review of finance, 17(1), 1-33.
- Adelino, M., Schoar, A., & Severino, F. (2018). The role of housing and mortgage markets in the financial crisis. Annual Review of Financial Economics, 10, 25-41.
- Chomsisengphet, S., & Pennington-Cross, A. (2006). The evolution of the subprime mortgage market. Federal Reserve Bank of St. Louis Review.
- Cook, N., Smith, S. J., & Searle, B. A. (2009). Mortgage markets and cultures of consumption. Consumption, Markets and Culture, 12(2), 133-154.
- Aalbers, M. B. (2016). The financialization of home and the mortgage market crisis. In The financialization of housing (pp. 40-63). Routledge.
