Over the past quarter of a century, the residential mortgage market has grown into the largest market for consumer debt. The market for mortgage-backed securities or MBS, in which mortgage cash flows are packaged and distributed to investors, has grown concomitantly. According to the Securities Industry and Financial Markets Associations (formerly the Bond Market Association), the market for mortgage-related securities surpassed the U.S. Treasury market at the end of 1999 to become the largest cash financial market in the world. By the end of 2006, the total amount of MBS outstanding was $6.4 trillion, 49% larger than the market for Treasury debt.
In addition to their size, both the consumer mortgage and MBS markets have become increasingly flexible and dynamic. The MBS market has traditionally exhibited great creativity in constructing different products and structures to help a wide variety of investors meet their investment objectives, exemplifying the concept of financial market segmentation. Innovations first conceived in the 1980s, such as senior-subordinate structures and planned amortization class (PAC) bonds, have recently been joined by concepts such as super-stable or “sinker” bonds and corridor-cap floaters. In addition, complex analytical tools have been developed and refined in order to aid investors in valuing their holdings and assess relative value among competing investment alternatives.
The consumer mortgage market has also undergone a period of substantial ...