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Former Policymaker Discusses MDX
MDX swap pricing can play an important role in housing and mortgage public policy. To provide a perspective on its potential value, we asked a former regulator to share his views. Ed Golding is the former head of the Federal Housing Administration and the Executive Director of the MIT Golub Center for Finance and Policy. His thoughts about MDX are below.
Disclaimer: The views expressed in this article are solely those of the author and do not represent those of MIT.
The Market Needs a Tradeable Mortgage Credit Instrument
The value of US housing is $45 trillion, larger than the US Treasury market and almost the size of the US equities market. The agency MBS market allows for investors to take positions both long and short in interest rate and prepayment risk connected to the housing market. But there is no comparable, liquid market for the credit risk component of the housing market. Information on credit risk is available to the market through monthly reports on the delinquency status of mortgages. Harnessing this data into a tradeable index would allow market participants to express a view on the direction of US household credit and the housing market.
MDX is such an index. MDX indices reliably measure borrower credit events within six-month cohorts of mortgage loans. Credit events are clearly defined as borrowers who are experiencing credit stress, measured through government-mandated loan delinquency and modification reports. By referencing the broad universe of Ginnie Mae loans, Vista’s MDX.GN Series reflects aggregate US household debt trends and credit performance in a representative fashion. Ginnie Mae MBS accounts for 18% of the $13.9 trillion outstanding household mortgage debt. More importantly, the underlying mortgages in these Ginnie Mae MBS represent approximately 60% of delinquent mortgages in the agency space. Furthermore, Ginnie Mae has for over a decade committed to providing transparent and accurate reporting of loan level data that the MDX indices rely on.
Composition of the US Single Family Mortgage Market
$13.9 Trillion
MDX is a series of simple credit indices based on vintages of newly originated mortgages to a large segment of the household sector. In essence, MDX tracks the balance sheet of the American consumer. For instance, when credit scores are improving, and job losses are low, fewer loans are delinquent. Likewise, MDX tracks the health of the US single family housing market. When housing values increase, borrowers will have more equity to tap in avoiding missed payments. Thus, this index can become the easily understood measure for the credit risk embedded in US mortgages by vintage.
Indices summarize information and are often used for benchmarking and risk management purposes. The major benefit comes from liquid financial instruments based on MDX indices. A swap based on MDX will provide the market’s forward-looking view of the credit risk in the mortgage market. It will incorporate all market participants’ expectations about the future path of the mortgage market. As such, MDX swap transaction pricing would provide an early warning for housing bubbles, could be used as an input for setting guarantee fees, and could even be incorporated into countercyclical risk-based capital requirements in the mortgage market.
Policy decisions would not formulaically rely on these measures, but they would be important new inputs to guide policy, similar to how the Fed monitors the TIPS market to see the market’s forward view of inflation in deciding on the Fed Funds rate. Given the limited market data on mortgage credit risk available today1, the price of mortgage credit risk derived from a swap on MDX could prove even more useful to policymakers, regulators, and risk managers.
In summary, the introduction of MDX and the development of a liquid, cleared swap market would be a significant development on the public policy side. Having the market view of the five-year outlook for the housing market and consumer sector based on the underlying characteristics of recent mortgage originations would prove invaluable to a host of policy makers.
Author
MIT Golub Center for Finance and Policy
Former Head of the Federal Housing Administration
Disclaimer: The views expressed in this article are solely those of the author and do not represent those of MIT.