UPDATE 1-US mortgage bond market liquidity measure approved

(Adds details of plan, industry comment, background)

By Al Yoon

NEW YORK Jan 9 (Reuters) - An industry group on Friday said it approved a proposal aimed at boosting trade and prices in a key part of the $4.5 trillion market for guaranteed mortgage-backed securities.

The plan from dealers and the Securities Industry and Financial Markets Association allows the re-packaging of some structured mortgage bonds popular with banks and insurance companies into securities eligible for a more liquid market, according to a letter to SIFMA members obtained by Reuters.

Under the plan, dealers can re-package collateralized mortgage obligations, or CMOs, with attributes similar to plain-vanilla "agency" mortgage debt. Reconstituted issues can trade in the so-called "to-be-announced" (TBA) market -- one of the most active markets in the world where investors trade MBS before actually taking delivery of the bonds.

CMOs are created with MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae, structured to make cash flows and prepayment risks attractive to investors that manage liabilities. With premiums on liquidity rising in 2008, CMOs weakened relative to TBA bonds, denting returns and potential profit on new issues.

By improving CMO trading, those investors are more apt to buy in the market that strongly influences the state of funding for the U.S. housing market. MBS are already rallying as the Federal Reserve exercises its plan to buy up to $500 billion of the bonds in an effort to lower mortgage rates.

"By broadening the investor base, banks will be able to originate more mortgages because they will not have to hold them in their own portfolios," said Brodie Johnson, a director at Merrill Lynch who spearheaded the CMO proposal.

CMO bids began to improve in December on expectations that the proposal would be approved, he said.

Issuance of CMOs is crawling back, after falling to "virtually zero" in recent months from an average of about $25 billion a month in early 2008, he said.

"It is likely that the market will come fully back to life in several months," he said.

Before the Fed announced its MBS purchase plan, some traders expressed concern an increase in TBA-eligible issues could pressure prices by adding supply to the market. (Editing by Chizu Nomiyama)