The modern mortgage backed securities market emerged from a series of innovations driven by the need to manage risk and unlock capital locked in residential real estate. Understanding who created mortgage backed securities requires looking at a confluence of government policy, Wall Street ingenuity, and evolving financial theory spanning several decades.
The Governmental Foundation
The origin story begins not with Wall Street, but with federal agencies designed to expand homeownership and stabilize the banking system. In 1938, the Federal National Mortgage Association, commonly known as Fannie Mae, was created by Congress to provide liquidity to the mortgage market. It did not securitize loans in the modern sense but rather purchased mortgages from lenders, holding them in its portfolio. This action effectively mitigated the risk of long-term, fixed-rate loans for banks, encouraging them to lend more freely.
The Advent of True Securitization
The next critical step in answering who created mortgage backed securities as we know them today occurred in 1970. The Government-Sponsored Enterprise, Ginnie Mae, pioneered the practice of packaging pools of government-insured mortgages into securities sold to investors. This process, known as securitization, transformed illiquid mortgage loans into tradeable assets. For the first time, the cash flow from individual mortgages was bundled and sold as a single security, backed by the full faith and credit of the U.S. government.
Wall Street Enters the Arena
While Ginnie Mae provided the template, private Wall Street firms soon followed, leading to significant evolution in who created mortgage backed securities. In 1977, Salomon Brothers executed the first private-label securitization, creating a pool of mortgage loans that were not guaranteed by the government. This innovation allowed investors to access riskier, non-agency mortgages in exchange for potentially higher yields. The barrier to entry was the creation of Special Purpose Vehicles, or SPVs, which isolated the assets from the originating bank's balance sheet.
Structuring the Risk
As the market matured, the question of who created mortgage backed Securities shifted toward how the risk was structured. Investment banks began slicing these pools into tranches with varying levels of risk and return. Senior tranches received lower interest rates but were prioritized for payments, while subordinated tranches, often called "equity" tranches, absorbed the first losses. This structure allowed for the creation of Collateralized Mortgage Obligations, or CMOs, which further stratified payment streams to meet the specific demands of different investor classes.
The Role of Rating Agencies and Investors
For the market to function, trust in the underlying assets was essential, defining the modern participants in who created mortgage backed securities. Credit rating agencies like Moody’s, Standard & Poor’s, and Fitch played a pivotal role by assigning grades to these tranches based on complex models. These grades determined how much capital financial institutions had to hold against these investments. Consequently, institutional investors such as pension funds and insurance companies, who required safe assets, became the primary buyers of these securities, fueling the expansion of the market.
The Evolution and Impact
The landscape of who created mortgage backed securities continued to shift with the rise of private-label deals and complex financial engineering. The proliferation of subprime lending in the early 2000s changed the composition of the underlying pools, leading to products like Alt-A and Option ARMs. The securitization chain extended globally, with banks originating loans purely to sell them into the market. This intricate web of creation, distribution, and investment defined the modern financial system and its vulnerabilities.
