The modern mortgage backed securities market emerged from a series of financial innovations in the United States during the 1970s, although the conceptual roots of pooling mortgages trace back decades earlier. While the practice of bundling home loans existed in various forms long before, the specific creation of standardized, tradeable securities is generally pinpointed to 1970 with the formation of the first Government National Mortgage Association (GNMA) passthrough securities. This financial engineering solved a critical problem for banks, which previously had to hold long-term, illiquid mortgage assets on their balance sheets for the full duration of the loan.
Pre-Seeds: The Era Before Securitization
To understand when mortgage backed securities started, one must first look at the limitations of the pre-securitization mortgage market. Before the 1970s, mortgage lending was primarily a local banking activity. Financial institutions funded mortgages using their own deposits, and the loan remained on their books until the borrower paid it off or the bank sold it individually. This model presented significant challenges, including a lack of liquidity and a mismatch between the long-term nature of mortgages and the short-term nature of bank deposits. The market was constrained by the availability of local capital and the banks' balance sheet capacity.
The Birth of the Modern Market: 1970
The definitive answer to "when did mortgage backed securities start" in the standardized, Wall Street-traded sense is 1970. In that year, the newly created Government National Mortgage Association (GNMA), often referred to as Ginnie Mae, issued the first pool of residential mortgages as a security. These initial securities were guaranteed by the full faith and credit of the U.S. government because they were backed by loans insured or guaranteed by federal agencies like the Federal Housing Administration (FHA) and the Veterans Administration (VA). The establishment of this market provided a reliable source of funding for government-backed loans and laid the blueprint for the entire industry.
Fannie Mae and Freddie Mac Enter the Fray
While Ginnie Mae pioneered the concept, the market expanded significantly with the involvement of the two government-sponsored enterprises (GSEs) that had been created decades earlier. The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, which was originally established in 1938 to create a secondary market for mortgages, began issuing its own private-label mortgage backed securities in 1971. Two years later, in 1973, the Federal Home Loan Mortgage Corporation (FREDDIE MAC) joined the arena. The entry of these two entities transformed the market from a small government-facilitated operation into a massive, dynamic secondary market for conventional mortgages.
The Mechanics of the Early Securities
The initial mortgage backed securities created in the early 1970s operated on a straightforward principle known as a passthrough structure. Investors in these securities received a pro-rata share of the principal and interest payments made by the homeowners in the underlying mortgage pool. For example, if a security represented 1% of the pool, the investor would receive 1% of each monthly payment. This "pass-through" mechanism was relatively simple but introduced the complex plumbing of the modern mortgage market, connecting Wall Street Main Street through the flow of household debt payments.
More perspective on When did mortgage backed securities start can make the topic easier to follow by connecting earlier points with a few simple takeaways.
