Researchers with AllianceBernstein have published a new white paper discussing ways to attract private capital back into the mortgage market.
According to the paper's authors, Matthew D. Bass and Michael S. Canter, members of AllianceBernstein's structured asset portfolio management and research team, there is secular demand for income-producing assets (e.g., first-loss mortgage risk) from longer-term investors such as pension funds, sovereign wealth funds and insurers with longer-duration liabilities.
In their paper, Bass and Canter outline the following three key principles regarding the role of private capital in the mortgage market:
- government involvement in the market is necessary to ensure a stable market;
- the private market is better positioned than the government to price risk, and as such, private investors should provide first-loss capital to the market, while the government should provide catastrophic loss insurance to ensure stability during bouts of market stress; and
- in order to provide a more stable foundation for the housing market going forward, private first-loss capital should be unlevered, and the first-loss piece should not be credit tranched.
Bass and Canter also offer potential solutions for private capital sharing credit risk. They suggest that to ease the transfer of risk to private capital while averting the delays associated with trying to pass legislation, the government could reintroduce transactions that enjoy successful precedents such as Freddie Mac's Mortgage Default Recourse Notes and K-Series transactions.
According to Bass and Canter, the greatest chance of success will depend on the development of multiple private-capital-based options to provide the broadest and deepest investor base. They also emphasize that the long-term stability of housing finance should not be sacrificed for ‘quantity’ or lower mortgage rates achieved through increased leverage in the system.
‘The process of bringing private capital into the mortgage market will take time,’ they wrote. ‘If these changes are well communicated and the market is structured appropriately, we believe that there is a deep investor base with longer-duration liabilities that is ideally positioned to invest in first-loss mortgage risk over the long term."