Tokenize This: Week 47 ~ Tokenized Mortgage-Backed Securities
Bring transparency and simplicity to the MBS markets.
One of my favorite financial movies of all time is The Big Short. I’ve covered it in my State of Security Tokens 2022 publication and am going to tap into it for inspiration right now.
With one of the best scenes being Jarred Vennett (Ryan Gosling) pitching Mark Baum (Steve Carrell) on his theory for shorting the US housing market, this brought to light an interesting possibility — could the “bedrock” of America really be in such bad shape?
The answer, in 2008, was yes. And similar future scenarios could perhaps be mitigated as more and more assets get onto the digital rails via blockchains of their choosing.
We know the primary cause of the housing crisis was exacerbated by the misrating of mortgage-backed securities stuffed with low-quality mortgages and debt. This created a public perception that the securities were in much better shape than the book value actually was — an extreme divergence between perceived value and intrinsic value.
Let’s take a look at 2 specific facets that blockchain technology can improve within the Mortgage-Backed Securities industry, and likely be applied to other comparable industries as well.
Value Adds
- Public transparency to the underlying assets within separate MBS
- Ratings of the MBS or its assets that are verified on the blockchain through entities like Morningstar, ClearRating, and Crypto Asset Rating
- Efficient and digital markets for brokers to more effectively connect buyers and sellers + improved price discovery
“Hey I have this at 101.5, you want it?”
-“I’ll do it for 100.6.”
“No, I won’t go below 101.2.”
-“Fill or Kill at 100.9.”
“Done.”
That’s how the existing Mortgage-Backed Securities market operates — for the most part. The trading of an MBS happens when one broker calls up another broker in their network and negotiates a price on the spot, which is either rejected or accepted. The brokers then move on and hope to conduct future business together in similar fashion.
Obviously there is some diligence involved but the transaction process is so old-school, which is cool when it comes to fast-paced negotiating and adrenaline, but likely holding the industry back when it comes to price discovery.
Instead, the MBS industry is prime for looking towards its own dedicated marketplace. The securities can all be tokenized at the MBS level for efficient trading on the secondary markets, with the long-term goal of holding tokenized mortgages within.
To clarify, this would require tokenization on the asset level — the underlying mortgages — in addition to tokenizing the Mortgage-Backed Security itself. This “double tokenization” feature would unlock the maximum amount of value to date, as it would provide transparency to not only the pricing and ratings of the MBS itself, BUT also transparency and ratings to the underlying mortgages.
For those keeping track, that lack of transparency is exactly what proved detrimental in the late 2000s.
So for a two-part improvement to the existing $5.5 trillion Mortgage-Backed Securities industry, tokenization brings unprecedented price discovery and transparency to all potentially parties involved, as the tokenization may occur on a public blockchain, a private blockchain, or a public-permissioned blockchain.
These types have their own accessibility factors which may suit certain industries over others. For instance, government bonds may be best facilitated on public blockchains for public viewing while private agencies may opt for private or permissioned blockchains in favor of their own confidentiality.
The Mortgage-Backed Securities industry is actually one of my favorite use-cases for tokenization given the sheer size of the industry and previous addressable problems. In fact, Security Token Advisors has seen several promising clients that are working to bring the proper technology to this industry, and we look forward to supporting and announcing these initiatives as they come to fruition.
New edition coming next Wednesday 1/26/22!
Disclaimer: This is not financial or investment advice and should not be interpreted as such. Please do your own research on investments and financial decisions before partaking in any ideas or ventures depicted in this publication.
