Case Assignment: Mortgage Securitization in Hong Kong
Capital markets provide the depth and flexibility to transform and expand key financial activities. Responding to economic demands the markets can bring innovative structures to transform basic financial arrangements and relationships. The innovation generated in more mature markets can provide examples for other markets. In this sense capital market activity is linked in a global movement to more complexity and efficiency.
As an example, in the United States residential mortgage activity broadened over seventy years ago with establishment of government supported agencies to assist in the distribution and investment activities to support the housing market. A key feature of the widened activity has been the creation of securities instruments which can be traded in the capital markets. Supporting this activity has been the use of techniques to alleviate credit risk by the pledge of mortgage assets to support the new classes of securities.
The case of “Mortgage Securitization in Hong Kong and Asia” reviews the actions of the Hong Kong government in the establishment of mortgage securities activities in the capital and financial markets of the territory. As such it demonstrates a series of important themes:
- Internationalization of capital market techniques;
- Maturation of the Asian capital markets to make use of these techniques;
- Adaptation of mortgage security structures to the particular conditions of the Hong Kong environment;
- Character and functions of alternative security arrangements;
- Interplay of banking and capital markets in the creation of innovative securities.
The case will be the subject for group and individual reports. It will be reviewed in a thorough class discussion. It is anticipated that there will be alternative viewpoints on the issues in the case. The class will work to resolve these viewpoints into the most effective analysis and recommendation applicable to the case situation.
The following issues should be addressed:
- Premise – “One precondition for developing a fixed-rate mortgage market was the existence of a fixed-rate debt market.” Explain.
- International Models – Review the U.S. structure for government agency participation in the development and maintenance of mortgage capital markets. Explain the series of steps taken to create the U.S. system. Compare them to the structure adopted in Hong Kong.
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- Emerging Market Issues – developing markets may have tax, regulatory and legal impediments to the creation of new products. Review the situations in other Asian countries and indicate what were the principal problems and the necessary steps for solution. What were the issues in Hong Kong?
- Suitability – asset-backed securities have become a major element of the capital markets in the U.S. and elsewhere. What were the predecessors in the use of assets as credit and income enhancements of debt instruments – in the corporate debt market? – in the state and municipal markets? What are the characteristics of mortgage securities which make them effective as a class of asset backed securities?
- The Government of Hong Kong was very motivated to develop the mortgage market. Explain its interest in terms of the advantages for the economy of Hong Kong; the requirements of consumers; the status and sophistication of the capital markets; and the stability of the banking system.
- Commercial Bank Participation – commercial banks and specialized housing banks were the major potential participants in providing the assets for the mortgage market. Explain the potential advantages of participation for the Hong Kong institutions. Outline the actual advantages which were provided to the institutions by the structure provided by the Hong Kong Mortgage Corporation.
- Alternatives – How would the Hong Kong Government system compare to one in which banks remained in control of direct sale of mortgages to investors? How would it compare to a privately organized system in which securities companies packaged mortgages for sale to investors?
- Capital Markets functions – the HKMC appointed four banks as market makers for mortgage securities. Explain the importance of market trading for the success and expansion of the mortgage activity in Hong Kong’s capital markets.
- Economic Conditions – the Asian economic crisis in 1997 had a severe impact on economic conditions in Hong Kong. There were important changes in interest rates, construction and development of new residences, vacancies of residences, and overall economic activity (Exhibits 5-9). What were the potential implications for the mortgage capital market system from these developments? How would the impact compare to the possible damage in a system without the government’s system?
- Choices for John Lee’s Bank – if you were senior management at the bank what would be your concerns with participation of the new system? What would your decision be and how would you justify it to your Board of Directors?
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