February 2007 Paper: How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions?
Executive Summary
The mortgage-backed securities (MBS) market has experienced significant changes over the past couple of years. Non-agency (“private label”) securities, which are not guaranteed by the government or the government sponsored enterprises, now account for the majority of MBS issued. This report reviews the rise of collateralized debt obligations (CDOs), the relaxation of lending standards, the implementation of loan mitigation practices and whether these structural changes have created an environment of understated risk to investors of MBS. The authors go on to measure the efficacy of ratings agencies when it comes to assessing market risk rather than credit risk. They determine that even investment grade rated CDOs will experience significant losses if home prices depreciate, leading to broader imbalances in the U.S. economy that, if left unchecked, could lead to prolonged economic difficulties.
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