Back in 2016, as I was about to leave Fannie Mae, the company was developing a securitization platform with its primary competitor, Freddie Mac. Today the Common Securitization Platform (the firms aren’t known for their creative branding) issues a uniform mortgage-backed security (UMBS). Mortgage-backed securities are an investment instrument backed by the cash flow of pools of residential mortgages.
The new security is aimed primarily at increasing liquidity of the bonds issued by the two giant government sponsored enterprises (GSEs) here in the United States. For readers in other parts of the world, note that there is not a comparable government framework like the GSEs for the provision of mortgage credit. European or Asian governments haven’t pursued a strategy of higher rates of home ownership through focusing on reduction of bank funding costs on mortgage loans or removal of loans from bank balance sheets.
One of the benefits of the US system is that mortgage securitization enables long-term (e.g., 30 years) fixed mortgage rate loans aimed at reducing the cost of homeownership. Having said this, mortgage and other asset-back securitization is growing across the world, just not with the same type of governmental support.
I have been thinking about this project lately in relation to solutions around the blockchain and tokenized assets that ChromaWay is developing. The GSE single security project is actually quite complicated, but is mostly about aligning the ways that the enterprises structure bonds including paying investors within 45 days, reducing prepayment risk, and developing common issuance plumbing. So, what does the blockchain have to do with this?
Blockchain is about a lot of things, but it's primarily about the use of a type of public infrastructure for shared, transparent record keeping. So, whether you are designing a system to account for cryptocurrencies or investment securities, the idea is that the use of public networks, transparent codified agreements, and the consensus-oriented governance can contribute dramatically to a more even playing field for all participants.
Some economists refer to this concept as “mechanism design.” Nobel prize winner (2007) Eric Maskin writes that “A mechanism is an institution, procedure, or game for determining outcomes...We begin by identifying our desired outcome or social goal. We then ask whether or not an appropriate institution (mechanism) could be designed to attain that goal. If the answer is yes, then we want to know what form that mechanism might take.” Maskin also advises us to pay particular attention to the” mechanism designer” for they have primary influence on the desired outcomes. This is highly relevant in the GSE case, and despite strong influence by their regulator (FHFA), in that the resulting platform design appears to have strongly reinforced their favored position.
This is not to diminish the sizable achievement of the project and benefits for other market stakeholders. For example, the firms are still in conservatorship, so presumably a single platform and security means a better deal for taxpayers from a long-term cost and revenue perspective. From a design and implementation perspective, merging the securities, policies operations of two competitors was a herculean task that appears to have gone off without a hitch in the market.
Still, after five years and reportedly $2 billion to develop and manage the cut-over, it continues to be a platform run by a duopoly that guarantees nearly 50% of all US mortgages. The securities will be purchased by the same types of exclusive investors (e.g., banks, pension funds, sovereign wealth funds, etc.), require the same large investor minimums (e.g. $25,000), involve the same intermediaries (e.g., large custodians), and involve distribution through the same networks of fee-charging brokers and bankers. As an aside and on a much smaller scale, in the blockchain world we are seeing the second generation of tokenized digital securities with greater liquidity, lower offering minimums, new broadly accessible exchanges, asset transparency, and much improved price discovery.
Most importantly for our example, the “common” platform remains under the control of the two giant housing finance companies. As Barry Zigas, from the Consumer Federation of America, asks policymakers “Do they let Fannie and Freddie keep this upgrade of what will now become the nation’s primary securitization infrastructure? Or do they take the next logical step and put this critical infrastructure into the public’s hands?”
The concept of evolving a purely private platform towards a sort of public utility is also consistent with blockchain frameworks. Many blockchain projects (including ours) begin with primary control by a single entity. After all, narrow ownership is often necessary to harness the financial and human capital to establish a sustainable platform. The most successful blockchain projects will evolve towards some type of greater public stewardship to ensure they will be more responsive to stakeholders and more resilient to big economic and political shocks. This concept not only has implications for financial platforms in the US, but around the world.
In this mortgage-backed securities example, Zigas and others recommend forming a sort of public benefit corporation to operate the securities platform. It would not only be open to other issuers of mortgage backed securities, but it would also permit other private sector and government participants to provide credit insurance to distribute risk more broadly.
A public network with transparent records, driven by standard transaction contracts, and open to multiple issuers and insurers of assets? Can anyone think of a good mechanism design out there?
Hint: It begins with a “B.”
References
https://www.bloomberg.com/professional/blog/big-change-agency-mbs-big-deal/
https://vfccu.org/assets/recordings/Investing%20in%20MBS.pdf
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