Why Mortgage-Bond Investors Won’t Buy: They Don’t Trust Anyone

Alessandro Pagani, a money manager at Loomis Sayles & Co., says he knows why investors still aren’t ready to buy new mortgage securities without government backing.

“We need to address a fundamental loss of trust,” Pagani, whose firm manages $230 billion, said at a conference in Las Vegas this week. Investors must have confidence that their money won’t be treated as a “pot of gold” to be looted by banks, the government, loan servicers and even consumers, he said.

Pagani spoke on a panel with investors including Deutsche Bank AG’s James Grady and BlackRock Inc.’s Dapeng Hu, whose firms collectively manage trillions of dollars and could devote more money to funding U.S. homeowners -- but aren’t. The market for U.S. home-loan securities that lack government backing remains almost frozen for a seventh year, limiting options for borrowers and boosting risks for taxpayers.

Issuance of the debt, currently tied only to loans too large to be financed in government-backed programs, totaled less than $9 billion last year. The only loans being included are of such high credit quality that almost none default. That compares with an annual peak of $1.2 trillion before the financial crisis, which was partly fueled by similar debt.

Investors’ grievances include the U.S. government endorsing policies such as legal settlements with banks that entail reworking loans for consumers in bonds owned by investors. Regulators have also created new “risk-retention” rules meant to boost lenders’ desire to make good loans, yet instead are allowing issuers to skip holding stakes in most types of the debt.

Pecking Order

It’s clear to investors that “where we rank on the pecking order is not very high,” said Deutsche Bank’s Grady, head of the structured-finance team at the bank’s investment arm, which manages about $1.3 trillion.

Existing laws offer investors no protection from borrowers using home equity loans to later reduce their ownership stakes in properties, increasing default risks, said Hu, a BlackRock managing director.

Another common complaint: other parties to mortgage-bond deals fail to police loan servicers, to make sure lenders take back misrepresented debt or to ensure accurate disclosure about cash flowing in from borrowers.

Several investors endorsed a solution in which each transaction would hire an ombudsman, a term used by DoubleLine Capital executive Vincent Fiorillo on an earlier panel at the conference, which was arranged by the Structured Finance Industry Group and Information Management Network.

Other descriptions used for the proposed role included “deal manager” or “super trustee,” reflecting a belief that current trustees aren’t doing enough.

“We need to actually have someone with the right to do something” to protect investors’ interests, “rather than having something running on auto-pilot right into the ground,” said Scott Waterstredt, a director at MetLife, the insurer with more than $900 billion of assets.

Loomis Sayles’s Pagani said the market could be funding $200 billion to $300 billion today, if investors would actually buy.

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