1. Fixed-rate debt is debt that has a fixed interest rate. When there is a fixed interested rate it means that the market movements do not have any effect on the rate of this debt. Fixed-rate debt provides the basis for a fixed-rate mortgage, which is, essentially, “an interest rate that remains the dame for the life of the loan.” (bankrate.com) So, for a fixed-rate mortgage market to be able to work, there is a need for a fixed-rate debt market.
2. “In the 1930s, the Federal National Mortgage Association (Fannie Mae) in the United States began purchasing mortgages from commercial banks.” (HBS case, p2) Through this process, Fannie Mae started issuing new debt-based securities. This system was a new adoption of an arrangement called “pass through.” Pass through because the new security holders were passed on all the mortgage receivables, meaning that instead of the receivables being paid to the banks of origin, they were directly passed on the new holders. The “pass-through” since then caused property being the most common asset used in the asset-backed securities market.
Even with the securitization market development, the “mortgage-backed securities (MBS) remained the most common form of asset-based securities (ABS).” (HBS case, p2) And since the three largest mortgage companies backed these MBS transactions, the mortgage market became the second most significant debt market in the U.S.
The situation and development in Hong Kong were rather different. The mortgage-backed securities system was first introduced by Chase Manhattan in 1988 as a private placement. (HBS case, p5) Even though the introduction caused a number of other institutions to join, the process had not been very successful. A number of investors decided to stay away from this type of market as there was a “lack of conformity of the underlying pool of mortgages and the heterogeneity of issues.” (HBS case, p5)
However, in 1997, the government decided to establish the “HKMC” – Honk Kong Mortgage Corporation Limited. Through the establishment, the government was expecting significant benefits for the territory “in terms of facilitating the development of the local debt market and the secondary mortgage market in Hong Kong.” (HBS case, p5)
3. The situation in the developed markets – especially then the mentioned various tax regulations or legal impediments, the asset-based securities market was only in its beginnings in other Asian countries. Since the market was nowhere as advanced as in the United States, large foreign institutions haven’t viewed the region as profitable or the market as “liquid enough” for them to enter. Since the market has been fairly unknown, the countries lacked regulations and laws that would help control or develop the ABS. Also, the tax systems in these Asian countries were very different from the ones in the United States. Some countries, especially then the Philippines and India, practiced heavy tax systems that made it extremely difficult for the ABS market to even occur. Moreover, the fact that these other Asian countries didn’t have much of a secondary market that could potentially help and fund the ABS market only added to the list of obstacles.
The MBS was first introduced in Hong Kong, as mentioned above, by Chase Manhattan as a private placement. (HBS case, p5) The situation was also complicated as a lot of investors decided not to pursue business at first as there was a “lack of conformity of the underlying pool of mortgages and the heterogeneity of issues.” (HBS case, p5)
4. “An early prototype of the ABS model kicked off in Prussia after the seven years’ war destroyed farmland in the mid-18th century.” (HBS case, p2) Postwar, everyone needed capital and the farmer felt desperate. The earlier mortgage bond – the ‘Pfandbriefe,’ was introduced by the government shortly after by the government. Such a bond could have been worth even a half of farmer’s property. Within this post-war system, the borrowers were the ones who paid “interest to the pool, which in turn paid the bondholders.” (HBS case, p2)
5. Through developing the mortgage market, the Hong Kong government was hoping to create a more diverse market that, at the same time provides more stability. As previously mentioned, Hong Kong was striving for the development of the secondary market that would secure more liquidity. The mortgage-backed securities market is generally considered to be less risky. Alongside with liquidity, such type of market also brings foreign investment as it makes the country global. The government of Hong Kong was hoping to become a new financial center and open up the Southeast Asian region to the world.
6. Since its establishment, “the HKMC’s mortgage securitization program was painted as a win-win initiative that could benefit from both the servicing banks and the HKMC.” (HBS case, p6) As the servicing banks had the right to acquire back the MBS that were securitized by mortgages, “its cashflow position would not change much before or after the securitization… the banks were also entitled to an annual service fee of 0.5% on the outstanding balance.” (HBS case, p6)
Alongside the previously mentioned benefits, there was also smaller risk exposure, the banks would be able to maintain mortgages cashflow as long as they had the Notes in possession or releasing of capital by “converting 50% risk-weighting mortgage loans into 20% risk-weighting HKMC’s guaranteed MBS under the capital adequacy regime.” (HBS case, p6)
7. Hong Kong had prepared what they called the Phase 2 which offered an extra set of steps that provided a guarantee for timely payment of principal and interest. The four-step process started with wrapping mortgage pools from banks into MBS and give guaranty to the securities, launching a multi-currency Euro note, aiming for credit ratings and lastly securitizing mortgages from “HKMC’s own retained mortgage portfolio.” (HBS case, p10) The mortgage-based securities with the guarantee of timely payment would be then passed onto the investors.
8. HKMC decided to appoint four banks – Dao Heng Bank, Deutsche Bank, JP Morgan, and Merrill Lynch, as market makers for potential inaugural issues of MBS. Hong Kong strongly hoped that “the quoting of bid and offer prices” by these four banks would immensely help in establishing the much-needed MBS secondary market. (HBS case, p8) HKMC also planned to launch the multi Euro currency, as mentioned above, and also two new products – single class MBS and multi-class MBS. Needless to say, Hong Kong tired extensively and through a lot of ways to achieve a more liquid market that would provide a sense of security for foreign investors.
9. After the crisis in 1997, Hong Kong was hoping to recover and provide a sense of security and confidence for foreign investors. This could only be done through the introduction of the MBS market. Through the MBS system, the Hong Kong government also hoped to prevent any future crisis like the one in 1997 was extensive and left a lot of damage in the economy.
10. I think entering the market will be extremely challenging in the case of John Lee’s bank. As the small of liquidity and the absence of secondary market are both ongoing issues, there is no positive guaranteed outcome. The government is also very involved in all these decisions, which does not make it any simpler for a bank, especially then when it is a private one, to enter the MBS market.
In my opinion, John Lee and his bank should wait with entering the MBS market. Clearly, the MBS market system is not entirely developed, and Hong Kong is still struggling with some implementation.