Are mortgage-backed securities backed by any guarantees?
Actually, any mortgage-backed security (MBS) guarantee depends on who issued it.
To review, an MBS is a security, created through the process of securitization, in which the underlying assets are loans made to individuals and companies who are using the funds to purchase buildings and homes. The mortgages are secured to the lender by the properties purchased by the borrowers and are often backed by some form of homeowners' insurance. However, this insurance will only protect the issuer of the mortgages (mortgagee), and not the owners of an MBS that is issued using the same underlying mortgage. Therein lies part of the risk to MBS investors.
If a large number of mortgagors begin to default on their mortgages, the lender will have a difficult time passing through mortgage payments to MBS owners. Depending on how diversified the underlying pool of mortgages is across demographic and geographic regions, the risk of a mortgagor defaulting may be mitigated. However, if a significant number of mortgagors begin to default on their loans, the mortgagee may default on its MBS, and investors will suffer, demonstrating the need for some form of insurance or a guarantee.
Depending on the issuer, an MBS may or may not be guaranteed. There are four main MBS issuers:
- Fannie Mae (the Federal National Mortgage Association) is sponsored by the U.S. government and can issue and guarantee MBS issues. It's a publicly traded company and was established to maintain capital liquidity and to ensure that low- to middle-income individuals are able to purchase homes. Note that Fannie Mae's guarantee is based on its own corporate health, and is not backed by the government.
Freddie Mac (the Federal Home Loan Mortgage Corporation), is similar to Fannie Mae in that it is also sponsored by the U.S. government and is owned by stockholders. It was created to provide competition in the secondary mortgage market, which Fannie Mae originally monopolized. Like Fannie Mae, Freddie Mac can issue and guarantee mortgage-backed securities, but its guarantee is not backed by the government.
Ginnie Mae (the Government National Mortgage Association) differs from Fannie Mae and Freddie Mac in that it operates as a government agency. It does not issue mortgage-backed securities and its guarantees are backed by the full faith and credit of the U.S. government. Furthermore, Ginnie Mae guarantees MBS issues from qualified private institutions. Ginnie Mae also has a more stringent guarantee policy in that it mainly guarantees loans that are insured by the Federal Housing Administration (FHA) or other qualified insurers.
- Private issuers also issue mortgage-backed securities. If a private issuer is qualified by Ginnie Mae, its issue is guaranteed by that governmental agency. If, on the other hand, it is not qualified by Ginnie Mae, then the MBS issue is not guaranteed. (To learn more, see Profit From Mortgage Debt With MBS and Behind The Scenes Of Your Mortgage.)