Wednesday, August 28, 2013

Agency Costs In Mortgages

One of the factors blamed for the meltdown in the real estate market in 2007 and 2008 was agency costs. Prior to that period, banks and other mortgage issuers would issue a mortgage to an individual, then immediately sell the entire mortgage to a company that would package mortgages and sell mortgage backed securities (MBSs) to bondholders. The agency costs arose because the mortgage and MBS issuers had no "skin in the game," meaning that if the borrower defaulted, the they did not take a loss. As a result, some mortgage issuers issued mortgages to anyone with a pulse since the issuer would not take a loss if the borrower defaulted.

Due to this agency cost, regulations were put in place to require mortgage and MBS issuers maintain skin in the game, meaning that if the borrower defaulted, the mortgage and MBS issuers would both share in the loss with bondholders. Six U.S. regulatory agencies have proposed that the regulations be loosened to allow banks and MBS issuers to reduce their exposure to mortgages that meet less stringent requirements. Under the new proposal, mortgages that meet a minimum standard from the U.S. Consumer Financial Protection Bureau will not require banks and MBS issuers to retain interest in the mortgage.