The secondary mortgage market is the financial market for the sale and purchase of mortgages and mortgage-backed securities.
Securities and bonds collateralized by the value of mortgage can take many forms including:
- Collaterized debt obligations (CDO)
- Mortgage backed securities (MBS)
- Collaterized mortgage obligations (CMO)
The secondary mortgage market was initially started by Ginny Mae with the intention to be a new source of capital for the market.
Whole loan vs securities
The secondary mortgage markets can basically be separated into two types:
- Whole loan markets
- Securities markets
Whole loan markets involve the trading of mortgages themselves. Meaning a lender buys the loan from another, effectively taking over the loan.
This can occur on a loan-by-loan basis or in blocks.
The securities markets involve the trading of securities backed by pools of mortgages.
For example, instead of a hundred loans changing hands, the hundred loans are pooled together and issued as securities against it. Sort of like a mutual fund containing a number of stocks.
These secondary markets increase competition resulting a downward pressure on interest rates.
And because lenders can effectively “cash out” immediately after closing a mortgage, it is a great source of liquidity.
Bigger borrowers market
The secondary market played a big role in helping the general public buy their own homes.
Before the inception of the secondary market, lenders were very risk-adverse as they were only interested in lending to grade-A borrowers.
However a lot of regular people did not meet that income and credit standard.
As the secondary market opened for business, investors with a bigger appetite for risks increased the the market for mortgage borrowers.
This is because what was once a taboo market for traditional lenders to move into, they now know that even if they were to diverge from their traditionally strict loan assessment practices and start lending to “less desirable” consumers, there is a secondary market to buy up the loans anyway.
This was the catalyst for the emergence of the sub-prime market and little to no documentation loans.
According to official inquiry findings, sub-prime mortgages played a crucial role in the financial crisis of 2008.