Case Study: Funding and Liquidity Considerations in the US Residential Mortgage Market

Stefania A Perrucci

This article was first published as a chapter in Managing Illiquid Assets: Perspectives and Challenges, by Risk Books.

The US mortgage debt market is the largest in the world and its characteristics, and in particular its funding, liquidity and risk-transfer mechanisms, have been shaped by history, as well as social and cultural aspects. Section 3.1 starts with a brief recap of this history. In Section 3.2, we discuss the primary market and the funding and liquidity aspects of originating and hedging mortgage pipelines, covering both warehouse financing and TBA¹¹TBA stands for “to be announced”, ie, the forward market in mortgage securities discussed further in the chapter. market in detail. We then move to the secondary market in Section 3.3, covering the economic aspects and capital requirements of both whole-loan and security execution.

In Sections 3.4 and 3.5, we analyse how fundamental risks and liquidity are priced in the mortgage market and discuss the process of price discovery for complex mortgage securities, as well as the role of dealers as liquidity providers, under both normal and stressed liquidity conditions. In this context, we introduce the concepts of