Mortgage-Backed Securities Get Their Futures Counterpart

December 6, 2000 ( Chicago Board of Trade said Monday that it plans to launch new contracts based on mortgage-backed securities in the first quarter of 2001.

The proposed futures and options contracts will track the prices of 30-year mortgage-backed securities issued by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Co. (Freddie Mac).

“Our members solidly support mortgage futures,” said CBOT Chairman David P. Brennan. “The U.S. mortgage-backed securities market is large and rapidly growing, and it is one of the biggest in the world without a futures-market counterpart. These new contracts will open a whole new field of business for our members and customers, and they will provide a natural complement to our flagship Treasury and agency contracts.”

The CBOT certified the new contracts last week under the new deregulation procedures by the Commodity Futures Trading Commission.

The CBOT’s new contracts will be useful for hedging risk in mortgage-backed securities, in real estate mortgage investment conduits and in strips. Previous hedging procedures, such as the cash-forward market, were less direct. The new contracts will offer superior hedges because they reduce counter-party risk and provide greater price transparency, lower administrative costs and (since they will be cash-settled) increased flexibility, said CBOT spokeswoman Maria Gemski.

The public will benefit, too. Over the long term, the new contracts may contribute to a more liquid mortgage market. This, in turn, may benefit America’s home owners and sellers by enhancing the ability of banks to offer competitive mortgage interest rates.

The trading potential of CBOT mortgage futures and options contracts is strong, said chief executive officer Dennis A. Dutterer.

“Combined with the unbeatable liquidity and efficiency of the CBOT marketplace, these contracts will provide our customers superior and more effective hedging tools for their risk-management needs,” Dutterer said.

Fannie Mae and Freddie Mac were created by the federal government in the 1930s to make home ownership more affordable. Fannie Mae chiefly packages mortgages backed by the Federal Housing Administration, but also sells some non-government-backed mortgages. Freddie Mac buys residential mortgages in the secondary market from S&Ls, banks and mortgage bankers.

These government-sponsored agencies have spawned a vast investment market. The hedge funds and other institutions that embraced collaterialized mortgage obligations have become a permanent feature of the financial landscape.

The CBOT will launch the new contracts on both of its platforms — the open-outcry trading floor and the new electronic system, called a/c/e, that arose from its alliance with Eurex.

Christopher Faille, Reporter


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