Mortgage loan packaging is simply the process of gathering together a group of similar mortgage loans, complete with their documentation folders, and selling those packaged loans as an asset unit to Wall Street investment bankers. The bankers in turn securitize those packaged loans into debt securities that they sell to pension funds, investment advisers, insurance companies, mutual funds and other institutional investors.
History of Mortgages
Prior to the late 1960s, a bank or a savings and loan made mortgage loans to people in its community, and kept those mortgages in its portfolio as investment assets. Since the bank couldn't easily make more loans than it had deposits, it took great care in selecting who would receive mortgage money. It also carefully monitored its loans to make sure they were performing according to the loan contract, and called in loans that appeared to be going bad. Eventually, it became clear that the Baby Boom generation would have such a large need for housing that banks and savings and loans would have a difficult time supplying the demand if they were limited to making only as many loans as their deposit bases permitted.
The Government National Mortgage Association (GNMA)
In the late 1960s, the United States experienced a huge budget deficit due to the expense of the Vietnam War and President Johnson's Great Society legislation which created Medicare, Medicaid and other social-help programs. As a result, the government could not afford to directly fund a housing expansion to supply housing to the Baby Boom generation. The solution was the creation of the GNMA, which would buy groups, or packages, of mortgages from banks, group them (securitization) into debt securities guaranteed by the U.S. Government and sell them to investors via the fixed-income market, like bonds. This flow of mortgage money back to the banks and savings and loans, through the purchase of their previously-made mortgages, allowed them to write mortgage loans far beyond the limits of their deposit bases.
As the housing market expanded during the late 1970s through the early 1990s, it became common for banks and savings and loans to make mortgages and sell them in packages to the Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC) and mortgage bankers. These organizations accumulated small packages of loans into large packages and sold them to Wall Street investment banks where they were securitized into pass-throughs, collateralized mortgage obligations and other forms of mortgage debt securities. These became a major part of the fixed-income marketplace where institutions bought for their investment portfolios.
The housing boom of the late 1990s through approximately 2005 was brought on by the Federal Reserve gradually lowering interest rates until many people found they could afford to buy houses thanks to the low mortgage rates available. Mortgage demand grew exponentially and new types of mortgages were created to fit the differing needs of borrowers. To accommodate the huge mortgage creation, mortgage packagers came into existence. They worked with mortgage brokers and banks, processing and placing mortgage applications. This made mortgage packaging relatively easy because all the paperwork was uniform, so mortgage packagers handled the applications, the banks funded the loans, the packagers sold the mortgages to Wall Street and gave the money back to the banks -- less handling fees, of course. It became a big business and a competitive one, which led to many of the bad loan creations that eventually caused the mortgage crisis of 2008.
Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.