Residential Mortgage-backed Security - Expanding The Concept

Expanding The Concept

In the late 1970s, a team from Salomon Brothers worked with Bank of America to create the first residential-mortgage backed security that wasn't government-guaranteed. A Salomon Brothers' bond-trader by the name of Lewis Ranieri was instrumental in this effort. He coined the term "securitizing" during this period after joining the project in 1977. Ranieri's ambition was to revolutionize the mortgage market, which at this time was heavily dependent on the government sponsored housing insurance institutions (Ginnie Mae, Fannie Mae and Freddie Mac). His plan was to discover a way to make the mortgage market a fully private affair., and to bring that goal to a reality, his team wished to create a security product "that could be bought and sold among investors". The idea was to allow private banks to issue loans and then sell those loans to willing investors looking for a steady stream of income, freeing up capital with which the bank could then issue additional loans. Despite working on the project for three years, the bonds the Salomon team developed were a commercial failure due to various state regulations and federal securities laws dating back to the Great Depression

To fix this problem, Ranieri helped create and defend before Congress the Secondary Mortgage Market Enhancement Act of 1984 (SMMEA). Alyssa Katz, in her 2009 book on the recent history of the American real estate market, wrote the following about Ranieri and SMMEA:

called on bond-rating agencies -— at the time, Moody’s and Standard & Poor’s -— to weigh in on each mortgage pool. As long as a bond got one of the top ratings from the agencies —- meaning that in the agencies’ opinions, investors ought to be confident of getting paid -— it could be sold. While the Securities and Exchange Commission would oversee the trading of these securities just as it did all investments for sale, no longer would the U.S. government exclusively manage the market in mortgage-backed securities, as it had through Ginnie Mae. “We believe that the ratings services do offer substantial investor protection,” Ranieri testified before Congress in early 1984.

This law opened up the door to allow "federally-charted financial institutions, including credit unions," the ability to "invest in mortgage-related securities subject only to limitations that the appropriate regulating board might impose." Loosening these restrictions created the private market for these products that did not exist when Ranieri was first developing them in 1977.