MORTGAGE BANKING

Sometimes known as mortgage companies or mortgage dealers, mortgage bankers are dealers in residential, commercial, apartment, condominium, mobile home, and special-purpose property mortgages, in general they are intermediaries among real estate purchasers using debt financing and vectors desiring mortgages or mortgage-backed securities. Mortgage bankers act primarily as a conduit between real estate borrowers and long-term lender.
    The need for mortgage intermediaries is fundamental, and mortgage bankers trace their domestic heritage to the farm mortgage companies that moved capital into the fertile western farms in the 1850s and that fueled the speculative land boom in the 1920s. a dramatic transformation in residential real estate financing followed the financial market collapse in 1929. As the 1929 stock market collapse spread to mortgage institutions, the frequency of mortgage foreclosures increased and the public demand for foreclosure relief grew more insistent. Mortgage moratoriums were in effect in five states by March 1933. After closing banks temporarily for a “bank holiday,” state legislatures across the country rushed to pass mortgage relief acts. On the national level, the federal government sought to induce flagging construction with the National Housing Act of 1934, establishing the Federal Housing Administration insurance program.
    Housing demand remained soft in the 1930s, in spite of governmental programs, and did not revive until after World War II. After a decade of modest building and the initiation of mortgage guarantee programs by the Veteran’s Administration (VA) and the Federal Housing Administration (FHA), the foundation was laid for a burgeoning national mortgage market. With the federal insurance programs, more borrowers qualified for high loan to value mortgages than would qualify for conventional mortgages. The VA and FHA offered mortgage lenders a standardized security, insured by an agency of the federal government, and issued by approved borrowers. Funds could flow easily across state borders and into capital deficit localities. The real estate mortgage was released from being a strictly local arrangement to become a nationally traded security. Although the mortgage market continues to be confined to the local market area of the lending institution, creation of standardized mortgage loan instruments, mortgage loan insurance, and national mortgage loan markets have expanded the geographical scope of mortgage intermediation in the United States financial markets. The mortgage banking industry currently lends approximately $8 billion to the housing industry at any one time, and it transacts an annual volume many times this amount.

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INVESTMENT BANKING SUMMARY

Investment bankers function as intermediaries between providers and users of capital by their activity in the market for new security issues as well as intermediating between investors in the remarketing of existing securities in the secondary markets.
    In the new issues market, the functions of the investment bankers include the negotiations and activities to make new securities acceptable in the market place (origination), the actual purchase of the new security from the issuer at a guaranteed price (underwriting), and the sale of the new security to the investing public through an underwriting syndicate (distribution).
    The investment banker also functions as an investment broker-dealer in the secondary securities market. The secondary market comprises organized exchanges and the over-the-counter market as well as the informal third and fourth markets where transactions are not brought to the organized markets.
    The broker-dealers are compensated for their intermediation activities in the secondary markets by the receipt of commission charges that are negotiated between brokers and their customers. Empirical study has shown that the commission charges are subject to economies for larger share volume and higher price stock transactions. Since income is based upon transactions volume and expenses involve large amounts of fixed costs for office and electronic equipment, brokerage firms experience great variation in earnings from year to year.

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THE MONEY MARKET

Although the term money market implies the existence of one market, the term refers to a group of financial markets. The money market means a group of markets for short-term credit instruments of high quality, such as Treasury bills, commercial paper, bankers’ acceptances, negotiable certificates of deposit, loans to or repurchase agreements with securities dealsers, and Federal funds. These instruments involve a small risk due to loss, because they are issued by obligors of the highest credit rating and they mature within 1 year.
    The market features highly efficient transactions machinery for executing trades. Centered in New York, a world financial capital, dealers in these securities are accessible to all parts of the United States and foreign financial centers by telephone. Information is given and trades are made by telephone among the numerous market participants. Major money-market traders are the large New York banks and large banks in other money-center cities, about thirty-four primary government securities dealers, approximately ten commercial paper dealers, a few banker’s acceptance dealers, and a number of money brokers who place short-term funds (such as Federal funds) in the money market.
    United States Treasury issues are the major security traded in the money market. The daily volume for U.S. Treasury bills averages about $25.7 billion. Volume is large because the securities mature within a short period, usually 90 days or less, and are “rolled over.” That is, maturing securities are repaid with a new issue by the same borrower. Furthermore, investors use the money market to earn interest on funds available for very short periods of time, such as 1 day or over the weekend. Investors may buy a security one day for resale the next. The large volume of transactions is executed at relatively low cost because of the large denomination of the trades ($1 million or more) and the relative ease of finding buyers for high-quality securities.

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Profits of Investment Banker and Brokers

Revenues of investment bankers and brokers depend heavily on the volume of securities handled. Most firms in this business are both investment bankers and brokers. These institutions are paid for financial transactions, not financial holdings, and they are paid a percentage commission based on the size of the transaction. For example, NYSE member firms’ revenues rise with increased trading activity on the exchange. However, the expenses of operating do not change in direct proportion to the change in volume. Expenses tend to remain fixed for many of the productive factors used by investment bankers and brokers. Such expenses as electronic information and data processing systems, administrative salaries, and building costs and rents are fixed expenses. After subtracting expenses from revenues, we find earnings because revenues vary more widely than expenses with volume, earnings rise and fall. Revenues, expenses, and earnings of NYSE member firms for the years 1972 through 1976 are given in Figure 13-3. We see losses for the low – volume quarters in 1973 and 1974. Also, we see relatively large earnings for the peak-volume quarters in 1975 and 1976.

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Portfolios of Investment Bankers and Brokers

Most investment bankers are also secondary-market brokers and dealers. They are traders who maintain small inventories of securities, which they plan to sell in the near future. Note that the total assets of $61 billion of security brokers are only a small fraction of the total assets of any of the thrift-type institutions. Sources of financing are principally commercial bank loans and customer credit balances. Commercial bank loans and customer credit balances. Commercial banks extend broker loans, which are very short-term (less than 30 days or on call) credits collateralized by marketable securities. Customer credit balances are amounts due to brokerage customers. Many customers prefer to leave credit balances at brokerage firms to pay for future security transactions, and brokerage firms accept the funds as a short-term source of financing.

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Commissions Brokers

Commissions Brokers are paid a commission for selling securities and arranging for the official transfer of ownership. The commission is negotiated between the broker and the investor for each transaction. Large institutional traders are able to negotiate lower commissions than individual trader, because institutional traders need proportionately less advice and personal service than do individual investors. In general institutional traders pay 40 to 50 percent less than individual investors for comparable transactions. The characteristics of the transaction are important determinants of the amount of the commission. The number and price of shares traded account for most of the difference in commissions charged for institutional transaction commissions. However, the commission charges do not increase proportionately with increases in the number of shares or price of shares traded.

The commission increases only 38 percent when the price increases by 100 percent. A very substantial discount is given for larger dollar volume transactions when the increase is due to higher prices. If we compute commission changes for increases in the number of shares traded, we find that commissions increase by 95 percent when share volume increases by 100 percent. Overall, commissions depend primarily on the number rather than the price of shares traded.

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Securities Trading

After securities are distributed to the investing public, they are traded in the secondary market. Organized securities exchanges, independent brokers and dealers, informal exchange arrangements are all part of the vast and complex secondary market. In the jargon of the industry, there are four markets:-
1.  Organized national and regional exchanges, such as the New York and American  Stock Exchanges and the Pacific Coast Stock Exchange
2. Over-the-counter market, which is composed of securities dealer and coordinated by the National Association of Securities Dealers (NASD)
3. Third market, where securities listed primarily on the New York Stock Exchange (NYSE) are traded by dealers without going through the Exchange
4. Fourth market, where large investors buy and sell directly among themselves.

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