Origins

• Mortgage-backed securities emerged in the financial markets in 1970, according to 2003 testimony before the House of Representatives Subcommittees on Housing and Community Opportunity; and Financial Institutions and Consumer Credit. According to the testimony of Cameron L. Cowan representing the American Securitization Forum, mortgage securitization grew from nothing in 1970 to $6.6 billion by the second quarter of 2003.
  
  Securitization is traced to the Government National Mortgage Association, commonly called Ginnie Mae. According to the Cowan testimony, Ginnie Mae guaranteed the first mortgage securities made up of mortgages backed by the office of Housing and Urban Development (HUD) and Veterans Administration (VA). This practice was copied by other government agencies like Fannie Mae and Freddie Mac to create a secondary market for mortgages to promote home ownership.
  
  

Liquidity

• The securitized mortgage innovation begun by Ginnie Mae made the mortgage market very liquid. Before securitization, lenders assumed all the risk from making mortgage loans and trading loans was a costly transaction. Securitization made trading mortgages easier and cheaper to do, making mortgages liquid assets. The increase in liquidity made the mortgage market more attractive to lenders and investors.
  
  

Collateralized Mortgage Obligations

• The model of pass-through securitization developed into a collateralized mortgage obligation to address the risk of mortgage prepayment. Pass-through securities depend on homeowners making regularly scheduled mortgage payments for the life of the loan. However, investors lost valuable cash flow if homeowners paid off mortgages ahead of schedule. To address prepayment risk, Fannie Mae further innovated mortgage securitization by offering collateralized mortgage obligations (CMO) to investors. A CMO offers investors different classes of cash flow called tranches. Each tranche is subject to a varying degree of prepayment risk allowing investors to buy into a particular tranche depending on risk tolerance.
  
  

Tax Reform Act of 1986

• The Cowan testimony shows that the Tax Reform Act of 1986 created the Real Estate Mortgage Investment Conduit (REMIC) to issue CMOs. According to Cowan, the majority of CMOs are issued as REMICs. REMICs contribute some key developments to the history of mortgage securitization. For instance, REMICs come with much more simple tax regulation and pay higher interest payments to investors who assume greater risk and come in different maturities. These characteristics now make up standard features built into mortgage-backed securities.