A mortgage aggregator buys home mortgages from banks and other loan originators, packages them as marketable securities, and obtains a rating on each bundle that describes its investment risk, primarily from one of two large rating services. The aggregator resells these risk-rated mortgage bundles to large institutional investors, primarily insurance companies, hedge funds, and very wealthy private clients. Mortgage aggregators contributed to the 2007 sub-prime mortgage meltdown.
Old-School Mortgage Lending
For many decades, a borrower who obtained a mortgage loan had a decent credit rating and a verified financial history showing the borrower's ability to pay off the loan. The borrower made a substantial down payment, often 20 percent of the purchase price. The result was commonly a 30-year mortgage loan with a fixed interest rate. These loans were usually retained and serviced by the institution originating the loan.
The New Paradigm
Over time, banks began selling their mortgage loans to others. One reason for this change was that much of the lender's profit from a mortgage occurs at the loan's closing. Thereafter, it might take 15 or 20 years for the lender to fully recover its investment. If, instead of retaining loans, banks sell them off in bulk, the funds become immediately available to make more mortgage loans. The financial middleman making this rapid turnover possible is the mortgage aggregator: a financial entity that buys mortgages from lenders and packages them for resale to others. The aggregator must have extensive financial resources, because mortgages are commonly bundled by the hundreds. The aggregator must also have sufficient weight in the financial industry to encourage favorable securities ratings and fast sales, and the aggregator must have a good reputation with investors that buy bundled mortgages.
What Could Possibly Go Wrong ... Did
Prior to the sub-prime mortgage meltdown of 2007, mortgage aggregators were viewed as facilitators that enabled the flow of credit to homeowners. Afterward, they were often blamed for the crisis. But, as a Harvard University study notes, the problem was systemic. Once loan originators no longer held mortgages to maturity, they relaxed their borrowing standards. Many loans were made without verification of income for little money down. Aggregators, if they understood the risks such loans presented, bought them anyway and quickly bundled them for resale. Responding to industry pressure, rating agencies, according to a Duke University study, gave high ratings to junk-quality securities. Buyers of these securities didn't investigate what they were buying, relying on their securities ratings instead. Eventually, the house of cards collapsed. Hundreds of thousands of homeowners defaulted, and many of the institutions involved, such as Lehman Brothers and Bear Stearns, were liquidated for pennies on the dollar.
The federal financial reforms that followed the mortgage meltdown, notably the Dodd-Frank Act, and the Secure and Fair Enforcement for Mortgage Licensing Act, attempt to increase the safety of the mortgage lending system going forward. Title IX, Subtitle D of the Dodd-Frank Act specifies new requirements for mortgage aggregators, who remain essential components of mortgage lending in the U.S.
- Promontory Financial Group: The Future Government Role in the U.S. Mortgage Securitization Market
- Joint Center for Housing Studies of Harvard University: Understanding the Boom and Bust in Non-Prime Mortgage Lending
- MIAC: Best Practices in Mortgage Pipeline Risk Management
- Bloomberg: Subprime Collapse to Global Financial Meltdown-Timeline
- Cornell Legal Informaton Institute: Dodd-Frank - Title XIV - Mortgage Reform and Anti-Predatory Lending Act
- Kenan Institute for Ethics: Greed, Negligence, or System Failure? - Credit Rating Agencies and the Financial Crisis
Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.