UPDATE 1-Mortgage securities market seeks liquidity measure

(Adds other CMO holders also affected in 3rd paragraph)

By Al Yoon

NEW YORK, Nov 5 (Reuters) - An industry group is seeking comment on a proposal aimed at boosting trade and prices in parts of the $4.5 trillion market for guaranteed mortgage-backed securities.

The Securities Industry and Financial Markets Association's plan would let dealers re-package a type of structured mortgage bond into a security eligible for a more liquid market, according to a letter to SIFMA members obtained by Reuters.

Re-packaging collateralized mortgage obligations, or CMOs, with attributes similar to plain-vanilla mortgage bonds could increase their values and help solve a nagging problem for dealers and other holders who have found the securities tough to sell as the global financial crisis turned investors away from risk. CMOs are created with basic "agency" MBS, but structured to make cash flows and prepayment risks attractive to investors.

A recent slump in trading in the overall market for guaranteed MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae has been blamed for inflating mortgage rates that banks can charge to borrowers. Pricing on CMOs are now "significantly lower" than MBS with the same attributes, creating a negative arbitrage, SIFMA said in its letter.

But making new bonds based on CMOs eligible for the "to-be-announced" market -- where generic issues are bought and sold before the bonds are actually delivered to investors -- would lay additional supply on the market as it adapts to softened demand from investors such as foreign buyers, Fannie Mae (FNM.P) and Freddie Mac (FRE.P).

TBA issues offer some of the financial markets' best liquidity, an attribute more dear to traders and investors in turbulent times.

"It's one way to facilitate a market," said Matthew Peterson, a trader at RBC Capital Markets in New York.

However, investors are not expanding balance sheets, and if "all it does is increase supply, is that something we want to do?" he asked.

SIFMA executives declined to comment on the proposal, a spokeswoman said.

Supply for MBS paying 5.5 percent interest -- a large segment of the overall market -- in CMOs is about $116 billion, he said. Something less than that could be made into the new securities known as re-REMICs, or re-real estate mortgage investment conduits, he said.