In the 15 years since the Financial Crisis, risk management has changed drastically across the marketplace. Global systemically important banks (GSIBs) increased capital. Derivative valuation and collateral process were standardized and moved onto centrally cleared exchanges. Trade-based SOFR replaced opinion-based LIBOR.
However, the mortgage market, one of the largest bond markets in the world, continues to transition even today. According to SIFMA data, the agency mortgage market in 2022 was worth nearly $11 trillion, slightly less than double 2008’s $6.3 trillion. However half of mortgages are now originated outside of the banking system according to S&P Global.
Risk remains in the mortgage production process. Each day billions of dollars of mortgage pools move though banks and nonbanks as they migrate to agencies like Freddie Mac and Fannie Mae who package them into agency MBS. Mortgage pools are “sold forward” like derivatives and called to be announced (TBAs). TBAs do not require collateral. Instead, counterparties keep lists and limits with whom they are willing to trade TBAs. While DTCC provides clearing services for TBAs, many firms do not centrally clear.
Collectively these items appear to leave the mortgage market susceptible to stresses. When banking portfolios reported losses in May of 2023, mortgage spreads over treasuries jumped to nearly 2%, levels not seen since 2008 and 2009 according to Bloomberg.
Better Risk Management Tools
Recently, CME Group launched TBA futures, centrally cleared, margined products that deliver physical TBAs through DTCC. Standardization of centrally cleared TBAs and robust margin processes removes counterparty risk while providing transparent pricing. Electronic trading allows the growing number of mortgage participants better risk management tools. All of this strengthens the large market supporting U.S. homeownership.
The growth since launch of TBA futures has been rapid, showing strong demand for risk management in the mortgage market.
15 years after the Lehman Brothers failure, and as Federal Reserve Chair Jerome Powell highlighted at Jackson Hole, the need for risk management tools is more relevant than ever.
In an adjacent market, CME Group Treasury futures are an example of supporting the most important debt market in the world with appropriate risk management tools. Today, price discovery and risk transfer for U.S. Treasury Note and Bonds occurs far more often in futures than the underlying cash markets.
This symbiosis of the Treasury market allows participants to safely invest cash in Treasuries while risk managing exposures with futures. As the mortgage market continues to evolve, the U.S. mortgage market might one day mirror this structure.
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