The readings make a point of distinguishing that ABS’, unlike MBS, have credit risk. Am I understanding this correctly? Why do MBS’ not have credit risk… or do they because they’re a subset of ABS’? Bah, this stuff sucks.
From what I understand, MBS are subdivided into 2 sub-categories. One backed by the full faith and credit of the governmental agencies like Freddie, Fannie and Ginnie. Such kinds of MBS are called the agency pass-through securities while all the others not backed by these 3 agencies are called as non-agency pass-through securities. I feel there should be certain rules to decide if the mortgage-pool under consideration is in the range of the loan size and the underwriting standards supported by the agencies to classify them as either agency or non-agency. So all those MBS deemed as agency pass-through securities are completely guaranteed against the credit losses by the US Govt, for the non-agency (private) MBS, they carry huge amounts of credit enhancements. So either ways, there is little, if not none, credit risk involved in MBS securities. For ABS, which are backed by pools of Auto Loans, CC Receivables, HEL’s, SBA loans, emerging-mkt loans, So evaluating the collateral’s credit quality is of utmost important, so as to make sure they generate sufficient cash-flows to service the investors staking at it. Thus we need to consider prepayment as well as credit risk for ABS and we repackage and redistribute those risks as per the various investor preferences using the Prepayment and Credit Tranching. … but I could be wrong on this
Thanks Dinesh, makes sense. I think what wasn’t clicking for me was: MBS - no credit risk - current subprime mess i.e. how could credit not be involved when the underlying security is being funded by a homeowner? But I guess the idea is, with agency MBS it’s not an issue cause of US Gov’t backing and with non-agency there’s enough credit enhancements for it not to be a issue. Does that mean the current situation in the markets is not so much credit risk, but an extreme case of extension risk? (hate to reply with another question, but I did!)
Freddie and Fannie are “not backed by the full faith and credit of the U.S. government” as of the late sixties or early seventies (freddie was not even around back then). However, they are considered to have equivalent credit quality. Congress is going to pass a regulatory board on oversite for these two insitutions to monitor their credit. I do not think that either has ever been bailed out from insolvency. I believe the issue in the market started as credit risk (subprime lending) coupled with the lack of regulation. Subprime filtered it’s way across other areas. E.g. Bear was investment grade according to the rating agencies despite being insolvent.
Only Ginnie Mae is truly considered agency bonds backed by the govt., as stated above, Freddie and Fannie are loosely grouped equivalents.
Just because this seems a little timely - Fannie was spun off in '68 as part of a budget balancing problem caused in large measure by rapidly escalating spending in Vietnam. Whether or not FNMA has the backing of the govt is a matter of debate, but it’s clearly not “full faith and credit”. I think there is no chance that Bernanke would let them default but everone is worried about a private corporation with implicit government backing having problems and causing the Fed to step in and do something icky (it’s jsut that my def of icky might be different from yours). Anyway, one way to look at it is that we have a Vietnam war problem 40 years afterwards. Who can guess where I am going with this…