WSJ: ‘Investors’ hot for riskier mortgage securities

Investors are “climbing over each other” to invest in higher-yielding mortgage securities like those issued by PennyMac, which RepoWatch wrote about December 9, according to the Wall Street Journal April 11.

These securities pay a higher return because they are backed by troubled mortgages and other loans that have a higher default risk than traditional loans.

Often the securities are created this way: Banks that hold the problem loans make repo loans to Real Estate Investment Trusts like PennyMac, which use the repo proceeds to buy the troubled loans from the bank. The trusts collateralize their repo loan from the bank with the loans they are buying from the bank. REITs like PennyMac then pool the loans and sell securities backed by them.

An important unknown is who is buying these securities. Buyers are generally called “investors,” and the Journal says they are “generally hedge funds and money managers.” But in the financial crisis of 2007-2008 many of them turned out to be investment and commercial banks.

These banks held one-fourth of the securities, used many of them as collateral for repo loans, and faced a financial crisis when repo lenders got worried about the quality of collateral and stopped lending.

This securitization financed by repurchase agreements, which is called securitized banking, was the root cause of the financial crisis in 2007-2008.

The Journal story does not mention repurchase agreements.