Mortgage Securities in Emerging Markets

Despite its recognized economic and social importance, housing finance often remains under-developed in emerging economies. Residential lending is typically small, poorly accessible and depository-based. Lenders remain vulnerable to significant credit, liquidity and interest rate risks. As a result, housing finance is relatively expensive and often rationed. The importance of developing robust systems of housing finance is paramount as emerging economy governments struggle to cope with population growth, rapid urbanization, and rising expectations from a growing middle class.

The capital markets in many economies provide an attractive and potentially large source of long term funding for housing. Pension and insurance reform has created large and rapidly growing pools of funds. The advent of institutional investors has given rise to skills necessary to manage the complex risks associated with housing finance. The creation of mortgage-related securities (bonds, pass-throughs and more complex structured finance instruments) provide the multiple instruments by which housing finance providers can access these important sources of funds, better manage and allocate part of their risks.

The use of mortgage-related securities to fund housing has a long and rich history in the developed world. Mortgage bonds were first introduced in Europe in the late 18th century and are a major component of housing finance today [EMF, 2002]. Mortgage pass-through securities were introduced in the US in the early 1970s and along with more complex structured finance instruments now fund more than 50% of outstanding debt in that country [Lea, 1999]. Today, mortgage-related securities have been issued in almost all European and developed Pacific Rim countries.

There have been numerous attempts to develop mortgage securities to secure longer-term funding for housing in emerging economies. The view has been that such instruments can help lenders more efficiently mobilize domestic savings for housing, much as they do in the developed world. In addition, mortgage securities are also pursued to develop and diversify fixed-income markets as a supplement to government bonds for institutional investors.

Despite the strong appeal of financing housing through the capital markets, there are significant barriers to the development of mortgage securities in emerging markets. Their success is dependent on many factors, starting with a strong legal and regulatory framework and liberalized financial sector and including a developed primary mortgage market. Perhaps not surprisingly, the experience in developing mortgage securities in emerging markets has been mixed. This paper will review the experience of introducing mortgage securities in emerging markets and explore the various policy issues related to this theme.

The organization of the paper is as follows: First, we review the rationales for introducing mortgage securities to fund housing; Second, we list the many pre-requisites that underlie successful introduction; Third, we explore the role that government can play in developing these instruments, from both a theoretical and functional perspective. Fourth, we examine the experience of issuing mortgage securities in emerging markets through short case studies of their use. From this examination we then summarize the lessons learned from these experiences, both in general and with specific reference to the proper role of government. Finally, we offer observations on the way forward to increase the use of mortgage securities in emerging markets.

The note will also discuss the various forms of state related support (guarantees, liquidity support, mandatory investment, tax breaks, and issuing privileges) that have been offered in order to secure the credibility and affordability of nascent mortgage securities, but that may also raise significant concerns about contingent liabilities and market distortions. The regulatory dimension of mortgage securities and securitization companies is an important determinant of their success and will be addressed as well.