Creating a Secondary Mortgage Market in Mexico
Mexican housing securitizations have not yet been geared toward foreign investors, but this situation is expected to change soon. The Mexican finance company Metrofinanciera plans a securitization of construction bridge loans that will be denominated in dollars and aimed at U.S. investors.
The details of the transaction have yet to be announced, but if the transaction is successful, it will no doubt signal an important step forward for the development of Mexico’s mortgage backed securities (MBS) market. Mexican President Vicente Fox has set an ambitious goal of building 750,000 new housing units annually beginning in 2006 (see chart 1). If Mexico’s MBS market begins to thrive (and manages to attract foreign investment), it would mark an important step toward bridging the housing gap in Mexico.
A new approach to policy
In recent years, policymakers in Latin America have sought to foster secondary MBS markets, arguing that such markets can expand sources of financing for housing and improve primary lenders’ risk management. The creation of these secondary markets contrasts with traditional Latin America housing policies, which have heavy state intervention and limited private sector participation.
Capital markets typically provide only short-term credit at high interest rates, conditions that prevent the growth of a thriving mortgage market, which requires the availability of long-term credit at affordable interest rates. In the absence of a thriving private sector primary market for mortgages, governments often set ceilings for interest rates, directly build housing units, and subsidize loans.
Primary lenders may find mortgages unattractive investments for a number of reasons. Credit risk may be too high, especially if foreclosure rules are weak. Even if governments provide mortgage insurance or other guarantees, mortgages are generally long-term assets, but lenders typically have short-term liabilities and are subject to liquidity risks. If lenders can’t sell the loans they originate, then they may find themselves capital constrained.
In Mexico, the primary market reflects these weaknesses. With a housing shortage of 5 million units, credit has been insufficient to meet housing demand, and low-income earners have typically had difficulty gaining access to financing. For the middle class, banks have played a very limited role; in 2002, banks provided only 8,849 (2.24 percent) of 394,867 home mortgages in Mexico (see chart 2).
Secondary markets offer the potential to dramatically increase the pool of financing for housing. They can overcome geographic constraints in cases where the supply and demand for funds are mismatched, and they can ameliorate the mismatch between short-term liabilities and long-term assets that primary lenders face. By matching mortgages with long-term sources of funding like pension funds, secondary markets can also allocate risk more efficiently. A thriving, standardized market will further reduce risks by lowering transaction costs and providing economies of scale.
Legislative boosts to markets
Although conventional wisdom suggests a healthy primary market must exist before a secondary mortgage market can be established, policymakers in Mexico have sought to boost both primary and secondary markets at the same time. But for any market to thrive, some institutional prerequisites must exist; for example, property rights must be enforceable, and enforceability in turn requires rules, methods of enforcement, and institutions that foster transactions.
One way institutions can help foster transactions is by standardizing loan applications and processing, thus reducing informational, administrative, and transaction costs. This step is vital to creating sufficient volume to package mortgages for sale in an MBS. In the United States and Canada, public agencies impose standardization, but in Mexico each bank has typically set its own standards.
Furthermore, although evidence suggests that there is a link between credit protection and deeper credit markets, creditor rights in Latin America remain weak. Creditors need certain conditions, including an independent, impartial, and efficient judicial system; clear land title; an effective title and lien registration system; and the ability to repossess in a reasonable time period at a reasonable cost.
Written by Michael Padhi, Jaime del Rio Castillo, and Stephen J. Kay. Michael Padhi is a graduate student in finance at the Robert H. Smith School of Business at the University of Maryland. He was a senior analyst in the Atlanta Fed’s research department until May 2003. Jaime del Rio Castillo is the institutional relations manager at INFONAVIT, the National Workers Housing Fund of Mexico. Stephen J. Kay is the coordinator of Latin American analysis in the Atlanta Fed’s research department.
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