Implementation of the Saudi Mortgage Law - Research Paper Example

Implementation of the Saudi Mortgage Law Table of Contents Table of Contents 2 Introduction 3 Overview of the Saudi Mortgage Law 3 Reviewing role of Fannie Mae and Freddie Mac in USA mortgage market in past two decades 5 Importance of liquid secondary mortgage market in an economy 6 Importance of secondary mortgage market 6 Relationship between money market and secondary mortgage market 7 Recommendations 7 Conclusion 8 Works Cited 9 Bibliography 10 Name of student: Name of professor: Course name: Date: Saudi Mortgage Law and secondary mortgage market Introduction After a continuous debate for over a decade, the Saudi Mortgage Law gained approval in 2012. News sources suggest that this approval will encourage various banks to expand their lending facilities in area of home purchase, as the practice of home purchase through mortgaging has so far been restricted in the country due to Shariah compliances (Bloomberg “Saudi Mortgage Law Opens Kingdom to Home Lending Surge”). However, the law was approved to enhance the real estate as well as financing market by developing provision of mortgage and similar financing arrangements through financial institutions. It was also gathered that the main purpose of envisaging the law was to develop secured financing in secondary market and to protect interest of borrowers as well as that of financiers regarding mortgages (Bloomberg “Saudi Mortgage Law Opens Kingdom to Home Lending Surge”). In the following sections, an overview of the law is discussed along with its impact on the KSA economy (Kingdom of Saudi Arabia). Additionally, role of Freddie Mac and Fannie Mae in the mortgage market of USA has been discussed along with an outline of importance of creating liquid secondary mortgage market in an economy. Lastly, recommendations have been provided regarding development of mortgage market in the KSA economy. Overview of the Saudi Mortgage Law The Saudi mortgage law is also known as the real estate mortgage law which is a union of five different laws regarding financing of real estate and control of finance companies. It was gathered that the enactment of the law was on hold for a very long time period considering the crisis in global real estate market that initiated with development and burst of housing bubble in the USA. These laws are being considered as of paramount importance for the KSA finance sector and real estate market because they are expected to ensure balance while incorporating innovation in the sector. Furthermore, these measures are expected to minimize growing gap in the financing market and emphasize on structured financing in the country’s secondary market. Fundamentally, these laws have been instated to ensure that investment in real estate sector is encouraged without deviating from the Shariah compliances. Basically, the mortgage law will make certain that both parties to a financing transaction will maintain transparency and adopt fair practices. The laws established that financiers should be honest, qualified, and have fair motives while borrowers must agree to various commercial terms and have strong credit rating that reflect quality present insight of their credit history. According to certain sources, one of the prime provisions in the mortgage law suggests that the financial arrangements thereof should be undertaken in a manner that is compliant with Shariah regulations (Bloomberg “Saudi Mortgage Law Opens Kingdom to Home Lending Surge”). In various laws in KSA region, Shariah compliance is mandatory and this law is no exception to that. However, against various notions regarding Shariah, the practice is exactly a deterrent to industrial growth. On the contrary, Shariah compliance strengthens equitable and fair transactions, calls for transparency along with information disclosure and provides protection to interest of all the involved parties (Saudi Arabia Monetary Agency “Finance Laws and Implementing Regulations”). Each of the five laws is summarized as follows. The mortgage law introduced framework for organizations that would finance real estate mortgages and is classified into four sections that comprise creating and registering mortgage, rights and duties of mortgagee and mortgagor, impact of registration of mortgage and situations that may lead to termination of a mortgage. The real estate finance law supports the Saudi Arabia Monetary Agency (SAMA) in regulation of real estate property mortgage market that includes organizations such as cooperative insurance company, bank, real estate refinancing company and other financing institutions. The law also addresses issues such as additional liquidity need which is provided by means of real estate development (RED) fund by the national government. Furthermore, this law overviews refinancing of various transactions and securitization and facilitation of the structured financing. The finance lease law comprises a series of provisions that help in recovering mortgaged asset as and when a borrower becomes insolvent. The law also governs creation and institution of finance lease contract and establishes responsibilities of various parties to the contract. The finance company law provide regime for various financing organizations that finance real estate as well as undertake other lease financing activities. The law is responsible for ensuring Shariah compliance in various financing activities such as consumer financing, credit card financing and others. It facilitates management and supervision of various financial institutions as per the regulations by SAMA. The law also has provision for setting up committee to oversee various disputes in this and the previously discussed laws. The execution law is a complementary act to all other four laws. It determines rules, procedures and regulations among other issues related to judgment and decisions in this context (Saudi Arabia Monetary Agency “Finance Laws and Implementing Regulations”). Reviewing role of Fannie Mae and Freddie Mac in USA mortgage market in past two decades Freddie Mac and Fannie Mae were founded around forty years back as government sponsored enterprises (GSEs) by the Congress. In this context, GSEs can be defined as privately owned financing organizations that have been established by government bodies for fulfilling certain public missions. These two GSEs were established to act as a steady source of fund for various residential mortgage projects across the country which included housing loans for families having low to moderate income earning. Freddie Mac and Fannie Mae carried out their activities through secondary mortgage market as they purchased the certified mortgages from various banks and other lenders and created mortgage backed securities. Following that, they securitized these by selling the securities to various investors (Acharya, Viral V., et al 1-232; Jaffee 5-29; Wallison and Calomiris 1-71). These companies besides trading securities to investors bought mortgages as well as MBSs for portfolio holding. They further funded these holdings through issue of debt obligations to investors as agency securities. Although, these GSEs did not have federal support regarding the MBSs and debt securities, yet their implicit federal guarantee made investors feel secure as they expected that the federal involvement would not permit the companies to default on obligations. Because of the federal guarantee, the entities enjoyed several benefits such as no restrictions related to registration of securities with SEC, line of credit from the Treasury, tax exemption and very low interest rate on borrowed fund and so on (Acharya, Viral V., et al 1-232; Jaffee 5-29; Wallison and Calomiris 1-71). These entities reinforced the perception that they are too big to fail among investors and dominated the secondary mortgage marketing by trading various kinds of mortgages. It was observed that prior to the financial crisis of 2007-08, these entities earned significant amount of profit from MBS trading. The GSEs experienced severe loss during the crisis and the federal government had to intervene. The companies were provided unlimited capital to maintain their solvency and to create secure mortgages. In 2009, it was determined that the GSEs financed a number of mortgages while most of these loans were insured by various federal agencies (Acharya, Viral V., et al 1-232; Jaffee 5-29; Wallison and Calomiris 1-71). Importance of liquid secondary mortgage market in an economy In this section, for appropriate justification to the nature of the subject it is essential to discuss two factors that are directly and indirectly associated with secondary market of mortgage. Firstly, role and need of secondary mortgage market has been discussed followed by establishment of relationship between money market and the secondary mortgage market. Importance of secondary mortgage market Financial innovation in last few decades can be held responsible for the growth and development of secondary mortgage market. The secondary mortgage market has been developed essentially based on the concept of secondary capital market, which however is more structured and controlled. Products of financial innovation that are traded in secondary mortgage market were primarily developed to minimize and hedge risk associated with the loans. In the secondary market, mortgage based loans are traded (bought and sold) between mortgage creators (commercial banks and other lenders) and securitization companies such as investment banks. The secondary market of mortgage is relatively vast and highly liquid as continuous trading takes place among mortgage creators, investment banks and investors. The secondary mortgage market bridges the gap between real estate industry and secondary securities market. In the secondary mortgage market, various mortgage loans are pooled together and combined to create MBSs which are sold to investors. In a well regulated market, trading of mortgages and MBSs would result in development of healthy credit spread and equal availability of credit. Trading of mortgages result in easy availability of fund for mortgage creators and on the other side, it increases the possibility of home ownership among low and middle income groups. Increase in homeownership also helps individual in building wealth and strengthen the real estate sector and thereby contributes towards positive growth of economy. Additionally, the economic growth is further induced through secondary mortgage market as it helps in mobilizing idle savings of in a variety of funds. As the financial sector strengthens through investments, economy of a country prospers. However, the secondary mortgage is not devoid of loopholes and lack of effective regulation may lead to disasters such as housing bubble and financial crisis of 2008 (Bernanke "The subprime mortgage market"). Relationship between money market and secondary mortgage market The overall money supply in an economy can be classified in short term and long term circulation. The short term money supply is managed through the money market while the long term investment and fund circulation is conducted through the capital market. Investors of money market are individuals who are interested in short term profit at a relatively low risk rate. The instruments of money market generate yielding within a year as these instruments mature within a period 365 days. The most common money market instruments are treasury bills, commercial papers and government bonds and securities. The fed fund rate or interbank rate is also an essential component of the money market. The rate of interest on treasury bills and other instruments and the interbank rate have significant effect on the mortgage rate (Taylor and Williams “A black swan in the money market"). When the treasury return improves, investors tend to sell other securities to invest thereof. Hence, to prevent investors from selling off their shares and to attract new investors, return on MBSs is also enhanced but only by means of charging high interest from borrowers. On the other hand, low return on treasury indicates low interest rate for borrowers and therefore greater stimulation in the economy (Taylor and Williams “A black swan in the money market"). Recommendations The growth of secondary mortgage market is necessary to mobilize fund from idle savings as well as to provide mortgage providers sufficient fund to provide loans as they cannot invest everything independently. The KSA is one of the emerging economies in the Middle East region and development of mortgage market will boost economic development in the country. Since all laws in the KSA region is significantly influenced by Shariah conformity, the governing principles of secondary mortgage market in the KSA region should adopt the same. Besides Shariah law being the norm, it will also help in protecting the market from the disastrous side effects of financial innovation. It has been already witnessed that deregulation of financial sector and lack of governance regarding financial innovation led to financial disaster in the US which further affected economies worldwide. It is recommended that the mortgage market in KSA region should maintain transparency with the investors regarding the nature and quality of the mortgages so that investors are well aware of the nature of risk associated therein. Conclusion The paper discusses formulation and usefulness of the Saudi mortgage law and its role in development of mortgage market in the KSA region. In this regard, sufficient emphasis has been put on institution of GSEs such as Freddie Mac and Fannie Mae in the US. So far, the greatest example of secondary mortgage market has been set by that of the US. However, the same market was highly responsible for financial blunder of 2008 as well where prominent financial institutions including Freddie Mac and Fannie Mae were on the edge of bankruptcy until the federal government got involved. Therefore, recommendations have been provided in the paper regarding development of secondary mortgage market in the KSA region so that similar regulatory errors are avoided. Works Cited Acharya, Viral V., et al. Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance. Princeton: Princeton University Press, 2011. Print. Baamir, Abdulrahman. Shari’a Law in Commercial and Banking Arbitration: Law and Practice in Saudi Arabia. UK: Ashgate Publishing, Ltd., 2013. Print. Bernanke, Ben. "The subprime mortgage market." The US Federal Reserve System. The US Federal Reserve System, 2007. Web. 14 November 2014. Bloomberg. “Saudi Mortgage Law Opens Kingdom to Home Lending Surge.” Bloomberg. Bloomberg, 2012. Web. 14 November 2014. Jaffee, Dwight. "The interest rate risk of Fannie Mae and Freddie Mac." Journal of Financial Services Research 24.1 (2003): 5-29. Print. Saudi Arabia Monetary Agency. “Finance Laws and Implementing Regulations.” SAMA. SAMA, 2014. Web. 14 November 2014. Taylor, John B. and John C. Williams. “A black swan in the money market." National Bureau of Economic Research. National Bureau of Economic Research, 2008. Web. 14 November 2014. Wallison, Peter J. and Charles W. Calomiris. "The last trillion-dollar commitment: the destruction of Fannie Mae and Freddie Mac." The Journal of Project Finance 15.1 (2009): 1-71. Print. Bibliography Gabriel, Stuart A., and Stuart S. Rosenthal. "Do the GSEs expand the supply of mortgage credit?New evidence of crowd out in the secondary mortgage market." Journal of Public Economics 94.11 (2010): 975-986. Print. Hermalin, Benjamin, and Dwight Jaffee. "The privatization of Fannie Mae and Freddie Mac: Implications for mortgage industry structure." Studies on Privatizing Fannie Mae and Freddie Mac (1996): 225-302. Print. Otto, Jan Michiel. Sharia incorporated: A comparative overview of the legal systems of twelve Muslim countries in past and present. Leiden: Leiden University Press, 2010. Print. Read More