The U.S. housing finance system changed significantly this week as the Uniform Mortgage-Backed Security (UMBS) went live, merging Freddie Mac and Fannie Mae To-Be-Announced (TBA) markets into one TBA market. While not a change you’ll see on your local news, the UMBS will have real, positive impacts on homebuyers, taxpayers, and investors from around the world, all of whom benefit from a mortgage market that is more vibrant, liquid and sustainable.
The culmination of this effort represents a remarkable achievement. We aligned and coordinated the activities of literally thousands of market participants, including investors, broker-dealers, financial market utilities, rating agencies, industry organizations and trade associations.
We passed several milestones on the way to our goal. Freddie Mac and Fannie Mae created a joint venture, Common Securitization Solutions (CSS), to build and administer a common securitization platform (CSP) on which to settle and track the new securities. The companies’ conservator, the Federal Housing Finance Agency (FHFA), established a new UMBS regulation. The self-regulatory organization for the securities industry (SIFMA), which publishes trading practices for Freddie Mac and Fannie Mae’s separate TBA markets, modified its rules for UMBS good delivery. Tax and accounting opinions were obtained from the Internal Revenue Service and Securities and Exchange Commission. Freddie Mac, meanwhile, helped investors understand how to exchange their legacy Freddie Mac Gold PC securities for the new UMBS. Moreover, all parties engaged in a massive communications campaign to make investors and other market participants aware of this effort.
In the end, it took seven years to get here. It was a long and complex effort, but it preserves the best of and even improves upon one of the greatest financial inventions of all time: The TBA market.
That’s how I’ve answered numerous questions about how the TBA markets work in the United States. Of course, it’s not magic, but what the TBA markets do is truly magical.
In essence, qualified homebuyers in the United States can go to a lender and receive a mortgage with a fixed rate—for 30 years. These lenders guarantee that rate at the time buyers apply for a loan, which significantly reduces the risk that the rate will go up before the loan is approved. Because the rate is fixed, there is no risk the borrower will ever be asked to pay more, even if benchmark rates go up over the life of the mortgage. And there’s more: Homeowners can pay off their mortgages early without penalty, which means the mortgage can be refinanced at a lower interest rate when rates drop. The homebuyer can do all of this without a large down payment. In the United States, standard down payments are 20 percent—and Freddie Mac has options to allow first-time and low-income borrowers to put down even less, as low as 3 percent.
This stability and predictability, combined with payments stretched out over a 30-year period, makes homeownership more affordable and forms the cornerstone of the American Dream. It happens almost nowhere else in the world, but it does here because of the TBA markets. It works like this: Freddie Mac and Fannie Mae buy mortgages from lenders for cash, which allows them to reinvest the money immediately in new loans at current rates. Not only does this allow lenders to make more loans for more homebuyers, it also prevents the lender from being locked into long-term loans at low rates.
We take the loans we purchase and package them into mortgage-backed securities (MBS)—bonds that offer a stream of revenue derived from borrower payments. The securities are sold globally to investors, including insurers, pension managers, money managers, REITS and foreign central banks via the TBA markets.
MBS are typically sold in the TBA markets on a “forward basis.” That is, investors agree to buy an MBS with a specified set of characteristics. The buyer won’t know until 48 hours before settlement exactly which mortgages will be part of the security. This arrangement works because Freddie Mac and Fannie Mae are vast in scale and have consistent standards, so that investors can count on getting what they asked for.
Liquidity Matters: The Genesis of the UMBS
Despite the success of TBA, the trading differences in Freddie Mac and Fannie Mae’s securities meant the market wasn’t as liquid or competitive as it could have been. The solution devised by Freddie Mac, Fannie Mae, and FHFA was the creation of a uniform mortgage backed security issued by both Freddie Mac and Fannie Mae. A combined TBA market where Freddie Mac UMBS and Fannie Mae UMBS are fungible and can be commingled into the same security effectively creates a larger, more liquid market.
The securities have the former structure of Fannie Mae MBS (including a 55-day delay as opposed to Freddie Mac’s 45-day delay) and the disclosures and policies that had been common to Freddie Mac securities. Investors generally do not need to know which company purchased the mortgages in the first place.
By combining these two securities markets, the U.S. housing finance system gets an exceptionally liquid TBA market—the second biggest bond market in the world—where investors can efficiently buy and sell highly sought-after securities with great confidence.
The path forward
While the UMBS has gone live with the first settlement of UMBS transactions, there remains work to be done and opportunities to be explored.
Investors in legacy Freddie Mac 45-day payment delay Gold PCs and certain other securities will have the option to exchange those securities for 55-day UMBS for the foreseeable future, and Freddie Mac maintains two paths for them to do so, including through broker-dealers on our Dealer Direct platform and directly through the Tradeweb platform.
Common Securitization Solutions will be monitoring and adjusting the CSP over time to ensure it works without friction and to the benefit of investors and sellers. That includes not just those who buy and sell on the platform today, but potential new entrants who may be drawn to the larger, more vibrant and fungible market.
And finally, we will watch to see how much and how well the TBA market for UMBS benefits the nation’s homebuyers. That’s a key part of our mission, and we are absolutely committed to it.
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