Loan securitization

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Loansecuritization

LoanSecuritization

Mortgagesecuritization is the process of reducing the risks associated withdefaults by borrowers through insurance. In the financial market, themain aim of every firm is to maximize their profits. Additionally,they would meet the objective when they consider lowering risksassociated with it. In most cases, the banks and other financiallending institutions are keen to reduce the nonperforming loans (GNMAMortgage-Backed Securities Dealers Association, 2008). Non-performingloans refer to the advances with high levels of defaults. Thenon-performing loans pose risks of loss to the lenders. To curb therisk, the financial companies (banks) have strategized on the bestways to minimize the loss. The financial entities insure the risks(Cortesi, 2004). In doing so, they transfer the risks to theinsurance companies at a fee. After transferring the risks, thecompanies bundle them into securities, which are then traded in thesecurity exchange market. The transcending effect of the transfer isthat they can advance more loans to the public without fear of riskof loss. It is through this line of thought that the GovernmentNational Mortgage Association (Ginnie Mae) came into existence (GNMAMortgage-Backed Securities Dealers Association, 2008).

Duringthe Great Depression of 1990, a federal housing association in theirbid to advance finances to the housing sector encouraged mortgagesecuritization through the financial backing of Ginnie Mae. Theprocess was that the lending institutions would give the mortgage tothe residence of the United States. Citizens are expected to pay theprincipal amount of the mortgage and the interests that accrue overthe years. To ensure less degree of default risks, the lenders insuremortgages. Ginnie Mae came to bundle mortgage loans into securities.With the financial backing of the government provided by the GinnieMae, the mortgages are sold in the securities exchange market (GNMAMortgage-Backed Securities Dealers Association, 2008). At this point,the proceeds from the sales of the securities are directly paid tothe lenders. With Ginnie Mae as the intermediary, the investors wouldbuy the bundled mortgage securities and be rest-assured of theperiodic payments from the securities (Cortesi, 2004). Arising fromthis, periodic proceeds from the payment of the mortgage owners willbe paid to the investors. If any default occurs, Ginnie Mae financialbacking will be used to pay the investors (Cortesi, 2004). Notably,Ginnie Mae deals with mortgages for those employed by the governmentor guaranteed by the government.

Oneof the ways securitization process benefits financial institutions(lenders) is that risks are transferred. When mortgage transactionsoccur, there might be default in payments by homeowners. The effectis that there is an increase in nonperforming loans. The bundling ofmortgages into securities and being sold to the stock markettransfers risks of defaults to the institutional investors and GinnieMae. The financial institutions, therefore, have the freedom of notlosing money due to defaults in payments (Cortesi, 2004).Additionally, the quick sale of the mortgages helps the lenders tomaintain their liquidity since they receive cash almost immediatelyfrom the proceeds of the securities sales. The move puts Ginnie Maeat a risk of losing the investment in the event of defaults. SinceGinnie Mae is directly linked to the government, the taxpayers` moneyis deemed to be at risk as well. Furthermore, with the sales ofmortgage to the securities market, the financial institutions do notgain much from the sales, as most of the interest would be enjoyed byinvestors (GNMA Mortgage-Backed Securities Dealers Association,2008).

References

Cortesi,G. R. (2004). Masteringreal estate principles.Chicago: Dearborn Real Estate Education.

GNMAMortgage-Backed Securities Dealers Association. (2008). TheGinnie Mae manual.Homewood, Ill: Dow Jones-Irwin.

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