While debating the reasons behind the 1998 volatility and discussing issues such as the delinquent servicer crisis at last week's New York City Fabozzi MBS conference, speakers also hypothesized as to why the face of the MBS market is constantly changing amid a dearth of liquidity.

During an opening plenary discussion analyzing the problems of 1998 and predicting future trends, panelists described a changing cultural, economic and social landscape that is causing a "natural evolution of the MBS market."

"Why have so many MBS products been created recently? Because there are no traditional borrowers anymore," said Anand Bhattacharya, executive vice president of Countrywide Capital Markets Inc.

"There is a new culture where quality of life is very important - a non-W2' culture, as I call it, where people have fluctuating income. There is a change in the demography, a new affluence in the system, and economic security is more important than ever before," Bhattacharya added.

"And this makes life difficult for the MBS investor."

Indeed, the current diversity in mortgage products is remarkable; borrowers and investors can choose from high loan-to-value loans, jumbos, super jumbos, prepayment-penalty loans, non-performing loans, re-performing loans and hybrid ARMs - just to name a few.

But this variety is necessary in today's cultural climate, says Bhattacharya. With employers increasingly giving bonuses and incentive schemes to workers, borrowers no longer have standard salaries; therefore, traditional mortgage documentation does not encompass the majority of applicants anymore.

"When people no longer have constant income, how does the originator assess the risk?," Bhattacharya asked the audience. "It becomes survival of the fittest for the investor and issuer, as they try to maximize spread and cut down on negative convexity. Never before do we have to give so much scrutiny to our underwriting policies and our risk management capabilities."

Last Year's Liquidity

Still, most of the panelists agreed that last year's MBS turmoil was caused by the turmoil affecting the entire bond market, not by something inherently wrong in the mortgage market itself.

According to Thomas Marano, senior managing director at Bear Stearns, mortgages were the last market to blow out last year, and this was mainly due to too much leverage.

"There was way too much leverage and someone pulled the plug," Marano said. "B&C originators booked residuals too high. Also, regional dealers were not committing the capital that the primary dealers are. The blow-out was a technical, rather than fundamental event."

Bhattacharya echoed that opinion, saying that the debacle reflected credit-related issues in the market, not a fundamental deterioration of credit. Instead, an expansion of credit found its way into "leveraged hands."

In contrast, however, Linda Stesney, managing director of residential mortgage finance at Moody's Investors Service, blamed last year's liquidity crisis on "flaws in the fundamental business model," and a "blind reliance on computer models."

While the home equity sector suffered the worst blow - largely due to gain-on-sale accounting, according to Stesney - the jumbo-A market also experienced some widening. On the other hand, Ginnie Mae manager John Jackson took a more neutral stance regarding last year's liquidity situation.

"Illiquidity is always going to happen," Johnson said. "Every dog has its day, and these types of panics have always occurred." - AT

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