Question:

What are the benefits and drawbacks of the Secondary Mortgage Market Enhancement Act of 1984?

Answer:

The Secondary Mortgage Market Enhancement Act of 1984 (SMMEA) was a legislation sponsored by the former Senator from Utah, Senator Edwin Jacob Garn. It was passed and approved, eventually becoming Public Law 98-440. It amended the Securities Act of 1933 as well as the Securities Exchange Act of 1934.

Key Provisions of the Secondary Mortgage Market Enhancement Act of 1984

Three of the most important provisions of the Secondary Mortgage Market Enhancement Act of 1984 are the following:

  • Established SMMEA securities or mortgage-related securities as defined in Section 3(41) of the Securities Exchange Act of 1934.
  • Allowed federally-chartered and federally-regulated financial institutions to invest in mortgage-related or mortgage-backed securities.
  • Preempted state laws so that state-chartered and state-regulated institutions can invest in mortgage-related or mortgage-backed securities.

Overall, the Secondary Mortgage Market Enhancement Act of 1984 did what it was supposed to do: strengthen the secondary mortgage market. Mortgage-related securities became widely available and accessible, even in states that had statutory limitations on mortgage-related securities. This led to the exceptional growth of the residential mortgage market.

Benefits of the Secondary Mortgage Market Enhancement Act of 1984

The Secondary Mortgage Market Enhancement Act of 1984 paved the way for the phenomenal growth of the secondary mortgage market.

When residential mortgage notes were securitized, investment flowed into the residential mortgage market. More investments meant more money to lend to homeowners and homebuyers. They also meant more loan options across-the-board.

Ultimately, SMMEA made home ownership possible for more Americans. Unfortunately, it had a specific weakness that played an indirect role in the recent home mortgage foreclosure crisis.

Drawbacks of the Secondary Mortgage Market Enhancement Act of 1984

According to the SMMEA-amended Securities Exchange Act of 1934, SMMEA securities are highly-rated or investment-grade, mortgage-related securities. Specifically, SMMEA securities should have been given one of the top two ratings by a reputable rating institution.

Unfortunately, SMMEA missed the fact that rating is highly subjective. Rating organizations are also largely unregulated. Some entities were therefore able to pool subprime and non-conforming mortgages with conventional mortgages to form investment-grade securities.

This in itself shouldn't have caused the secondary mortgage crash. However, lenders wanting to make a quick buck resorted to predatory lending practices and extended loans to unqualified borrowers. The result was massive borrower defaults and the subsequent crash of the secondary mortgage market. Since the Secondary Mortgage Market Enhancement Act of 1984 made mortgage-related securities virtually available to everyone, the effect of this crash escalated and spread to other sectors.

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