Residential mortgage-backed security
For example, with Fannie Mae, homebuyers had to make a minimum down payment of 10 percent of the home value, and the buyer's income had to be well documented and preferably from a periodic salary.
[12] 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.
His plan was to discover a way to make the mortgage market a fully private affair[15] and to bring that goal to a reality, his team wished to create a security product "that could be bought and sold among investors".
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[17] To fix this problem, Ranieri helped create and defend before Congress the Secondary Mortgage Market Enhancement Act of 1984 (SMMEA).
[18] Alyssa Katz, in her 2009 book on the recent history of the American real estate market, writes that SMMEA called on bond-rating agencies — at the time, Moody’s and Standard & Poor’s — to weigh in on each mortgage pool.
[19] 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.
[21] The MBSs of the "government-sponsored enterprise", Fannie and Freddie were considered to be "the equivalent of AAA-rated bonds" because of their high standards and suggestions of guarantee by the US government.
Since the most senior tranche(s) was like a "bucket" being filled with the "water" of principal and interest that did not share this water with the next lowest bucket (i.e. tranche) until it was filled to the brim and overflowing,[25] the top buckets/tranches (in theory) had considerable creditworthiness and could earn the highest credit ratings, making them salable to money market and pension funds that would not otherwise deal with subprime mortgage securities.
[26] One "typical" mortgage-backed "deal" from one of the peak years of private label subprime mortgage securities (2006) was described in the Financial Crisis Inquiry Report.
Dubbed "CMLTI 2006-NC2", the deal involved 4499 subprime mortgages originated by New Century Financial—a California-based lender—and issued by a special purpose entity created and sponsored by Citigroup.
[27] According to business columnist Joe Nocera, as of mid-2013, "the market for private mortgage-backed securities ... remains moribund"[27]; its financing has become dominated by Fannie and Freddie.
The result of these financial innovations was a secondary mortgage market existing outside of the government-sponsored entities that provided a massive growth opportunity for Wall Street banks.
[5] Financial journalists Bethany McLean and Joe Nocera argue that Wall Street securitizers encouraged relaxation of standards because poor-quality loans "meant higher yields".
