THE ECONOMIC BENEFITS OF MORTAGE-BACKED SECURITIES
Everybody seems to agree that mortgage-backed securities have played a major role in getting us into today's global financial mess. But can these financial instruments also do any good to the economy? Two economists at the University of Zurich in Switzerland, Mathias Hoffmann and Thomas Nitschka, argue that the answer should probably be 'yes'.
In a study presented at the Royal Economic Society’s 2009 annual conference at the University of Surrey, they identify some tangible macroeconomic benefits from the increased use of securitisation in industrialised countries' mortgage markets over the last 25 years. They conclude that the regulatory challenge is to improve, not to ban, securitisation in mortgage markets.
How should the benefits of mortgage-backed securities be measured? Some simple economic theory may help get answers: one way to assess the usefulness of a financial innovation is to ask whether it helps diversify risk.
Now, at a macroeconomic level, the ultimate risk we all face are fluctuations in consumption: our incomes and wealth may go up in booms and down in recessions. But to what extent a recession really hurts is determined by whether we have to move out from our house, sell the car or just cut down on the odd restaurant meal.
Hence, whether people are able to keep consumption stable over the business cycle is an important indicator of how well financial markets allow them to spread risk. And the extent to which an economy securitises mortgage debt may affect a society's ability to diversify such risk internationally. Economists call this 'international consumption risk sharing'.
What Hoffmann and Nitschka show is that the more developed a country's markets for securitised mortgage debt become, the more consumption risk it shares with other countries: while a one percentage point decline in a country's output (relative to the world average) leads to an around 0.8 percentage point decline in consumption in countries that do not allow securitisation in mortgage markets, the decline is only around 0.6 percentage points where secondary markets for mortgage debt are most developed.
Hence, securitising mortgage debt makes people's consumption considerably more resilient to the ups and downs of the business cycle in their home country. But it also means they become more exposed to shocks in other countries. This helps explain the speed with which the subprime crisis has spread globally.
One possible reason why securitising mortgage debt has such a strong effect on international risk sharing is that – before the rise of securitisation -- markets for residential mortgages used to be some of the most internationally segmented parts of the financial system. Securitisation has helped make the risks associated with mortgage debt internationally tradable.
So, repackaging and selling parts of their mortgage portfolio may actually have allowed banks to continue to provide credit to consumers even in downturns. This means they effectively provided international risk sharing to private households.
So much for normal times. But what about the current crisis? The authors find that international risk sharing decreases sharply in global asset market downturns, implying that countries find it hardest to share risk when it is most urgently needed. But this decrease hits all countries, independently of how developed their markets for securitised mortgage debt are.
These results suggest important policy lessons: yes, securitisation has generated some severe problems of moral hazard for example, by removing lenders' incentives to properly monitor credit quality, and through the opaqueness with which it was handled.
But in regulating these markets, policy-makers should also be careful not to pour the child with the bathwater: securitised mortgage debt also seems to have brought some measurable macroeconomic benefits. The regulatory challenge is to improve, not to ban, securitisation in mortgage markets.
ENDS
'Securitization of Mortage Debt, Asset Prices and International Risk Sharing' by Mathias Hoffmann and Thomas Nitschka (University of Zurich)
CONTACT:
Professor Mathias Hoffmann
University of Zurich
Institute for Empirical Research in Economics
www.iew.uzh.ch/itf
+41-44-634-5258