Friday, February 10, 2012

Banks Reducing Private CMO Exposure

A recent article in the Financial Times noted that banks are increasing holdings of collateralized mortgage obligations (CMO’s), credit instruments that aggregate mortgages into pools. The article noted that banks were increasing holdings of “the sliced-and-diced debt that some blame for the financial crisis.” Later in the article the author noted that some of these instruments were backed by the U.S. government and “generally considered safe.”

A closer inspection of the data shows that all of the growth in CMO holdings comes from the safe, government backed CMO’s. Moreover, banks have been allowing holdings of privately issued CMO’s to run off.

In fact privately issued CMO’s have decreased by 54% from their peak at the end of 2007, and currently represent 1.2% of bank assets, down from 2.7%. During this same period banks grew their holdings of government backed CMO’s to 3.5% of assets, from 1.3% in 2007. It is this growth alone that led to a 21% growth in CMO holdings.

Interestingly, the growth cited in the article looks only at the government backed CMO holdings. By not including the runoff in privately issued CMO’s, it overstates the growth of the entire market. In fact, the overall CMO growth did increase from the end of 2007 to present by 21%; however looking simply at government backed CMO’s for the same period makes growth appear to be 175%.

*The article mentioned appeared in the Financial Times on February 8th under the title “US banks snap up bundled mortgage products”

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