UK Rejects Fannie Mae-Freddie Mac Model for Mortgage-Backed Securities Market

A UK Treasury report rejects the Fannie Mae-Freddie Mac model for secondary markets in mortgage-backed securities. The Crosby Report also said that, because of a number of factors, the volume of mortgage-backed securities is not likely to return to the levels that existed before the crisis erupted. The process of securitization will be reformed, not abandoned, said the report. Reform must create transparent and fair markets for securitized assets so that lenders, issuers and investors can all fully understand the risks attached to the financial transactions. Ultimately, the UK Treasury envisions a gold standard for the asset-backed securities industry for the global marketplace that would promote cross-border investor confidence and thereby extend the appeal of mortgage-backed securities.

While commenters urged a temporary government guarantee for high quality mortgage-backed securities, the report noted that this would transfer credit risk from investors to the Government in a way that could distort incentives and create a moral hazard. Guarantee models come in a variety of guises, observed the report, often reflecting the specific country or historical contexts. In some existing structures, the government guarantee is implicit rather than explicit; though the recent experience of Fannie Mae and Freddie Mac illustrates that markets will tend to regard the former as equivalent to the latter. The report emphasized that an implicit government guarantee on mortgage-backed securities would not be an appropriate model for the UK to adopt.

On the broader issue of securitization reform, the report praised transparency proposals recently set forth by a group of European trade associations. Consistent with a recent Financial Stability Forum report, the trade groups stressed improved transparency and disclosure by issuers and the publication of periodic reports on European securitization markets. They also urged the development of global standardized reporting of transactions in conjunction with the American Securitization Forum, including standardized definitions and valuation principles.

The report favorably singled out the American Securitization Forum’s project on securitization transparency and reporting. The project is focused on developing specific market standards and practices, including templates for disclosure in securitization and model warranties to provide assurances to investors regarding the allocation of risk.