Subprime Mortgage

8 Key excerpts on "Subprime Mortgage"

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  eBook - ePub

  Banking Crises

  Perspectives from the New Palgrave Dictionary of Economics

  • Garett Jones(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Subprime Mortgage crisis, the

  The rise and fall of subprime lending

  A Subprime Mortgage loan is a residential mortgage loan that is particularly risky for some reason. The elevated risk may stem from the credit history of the borrower, the lack of a large down payment, or a monthly payment that is large relative to the borrower’s income (see Chapter 2 of Muolo and Padilla (2010) for a history of subprime residential lending). Subprime loans were unlikely to meet the credit-quality standards of the two government-sponsored entities (GSEs), Fannie Mae and Freddie Mac, which package so-called prime mortgage loans into mortgage-backed securities for sale to outside investors, and which eliminate credit risk by guaranteeing principal and interest payments to investors if the borrower defaults. While the GSEs did not have hard-and-fast cutoffs regarding borrower credit quality, they were historically less likely to securitize loans made to borrowers with poor credit histories.

  The subprime lending industry boomed in the 2000s as financial markets found ways to package Subprime Mortgages into marketable securities without the credit guarantees of the GSEs. The typical subprime deal offered investors a menu of securities with different income streams. Investors desiring the least risk would purchase the top “tranches” of the security, which generated highly predictable payments, while those willing to accept greater risk would purchase lower tranches. Any credit losses from the mortgages underlying the security would be allocated from the bottom up, so the top tranches would experience no credit losses unless the tranches below them were completely wiped out. Of course, investors holding the lower tranches were compensated for this risk with higher returns. Since most subprime loans ended up in securities, the typical subprime borrower was connected to his or her ultimate lender – a purchaser of the subprime security – through a long chain of financial intermediaries. A stylized description of the process might proceed as follows: a mortgage broker or loan officer would meet with the borrower and find a suitable mortgage product. A mortgage banker would originate this mortgage by supplying the money, perhaps after taking out a warehouse loan from a bank. The originating lender would then sell this mortgage to a Wall Street investment bank, using part of the proceeds to pay off the warehouse loan. The investment bank (such as Bear Stearns or Lehman Brothers) would assemble a large number of Subprime Mortgage loans into a tranched ‘private-label’ (that is, non-GSE) security for sale to investors around the world. This description is stylized because in practice different parties might play different roles at different times; a unit of an investment bank might originate and sell off one group of mortgages, while at the same time another part of the bank was packaging a different group of mortgages into a security. But the main organizing principle of the process was that intermediaries collected fees or other types of income, then passed the credit risk of their mortgages on to the next entity in the chain.

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  The Rise and Fall of the US Mortgage and Credit Markets

  A Comprehensive Analysis of the Market Meltdown

  • James Barth(Author)
  • 2009(Publication Date)
  • Wiley

    (Publisher)

  By providing loans to borrowers who do not meet the credit standards for borrowers in the prime market, subprime lending can and does serve a critical role in the nation’s economy. These borrowers may have blemishes in their credit record, insufficient credit history or non-traditional credit sources. Through the subprime market, they can buy a new home, improve their existing home, or refinance their mortgage to increase their cash on hand.

  “Unequal Burden: Income and Racial Disparities in Subprime Lending in America” U.S. Department of Housing and Urban Development April 2000

   

  Subprime borrowers typically have weakened credit histories that include payment delinquencies, and possibly more severe problems such as charge-offs, judgments, and bankruptcies. The borrowers may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios, or other criteria that may encompass borrowers with incomplete credit histories.

  OCC, FRB, FDIC, and OTS Federal Register July 12, 2002

   

  The term subprime generally refers to borrowers who do not qualify for prime interest rates because they exhibit one or more of the following characteristics: weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, or bankruptcies; low credit scores; high debt-burden ratios; or high loan-to-value ratios.

  Roger T. Cole, Director, Division of Banking Supervision and RegulationBoard of Governors of the Federal Reserve SystemMarch 22, 2007

  Given the intense media coverage of the Subprime Mortgage market, it may come as a surprise to learn that the distinction between prime and subprime borrowers is not clear-cut. Economists at the Federal Reserve Bank at San Francisco define subprime as “a lender-given designation for borrowers with low credit scores (FICO scores less than 620, for example), with little credit history, or with other types of observable credit impairment.”1

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  Affordable Housing Finance

  • K. Hawtrey(Author)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The subprime credit crisis There is widespread agreement that the economic upheaval, the defin- ing macroeconomic episode of our time, originated in the housing finance market, and that this was driven by the Subprime Mortgage sector, which is also known as the “Alt-A” or “non-conforming” sector. The crisis had been building for some time. The seeds of the problem lay in the accumulation of assets, especially securitized loans in the market for residential mortgage-backed securities (RMBS), whose liquidity and credit quality were less reliable than usual: the household sector equiva- lent of corporate “junk” bonds. The process of securitization entails the bundling together of underlying mortgages and their removal from the originating institution’s balance sheet, with ownership transferred by sale to the wider investment community. Securitized instruments trade on the secondary market, where they are bought and sold by third par- ties, not by the originator of the underlying assets nor necessarily by the initial investor. The idea of securitized mortgage markets goes back at least to the early 1960s (Jones and Grebler, 1961). 28 Affordable Housing Finance At the retail level, a typical experience ran something like this. In 2005, a couple had already purchased a home, financed with a 30-year fixed-rate prime mortgage based on a sound credit history. A mortgage broker in town called one evening offering to refinance their loan, with a new product that promised to allow them the flexibility to choose from different payment options varying from one month to the next. What was not made clear was that this was a “negative amortization” loan, with a ballooning principal that buried the couple deeper into debt even as they thought that they were paying down their mortgage balance. Other products around at that time included the so-called Ninja loans (“no income, no job, no assets”) and “liar” loans (no paper- work check of borrowers’ income).

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  The Banking Crisis Handbook

  • Greg N Gregoriou(Author)
  • 2009(Publication Date)
  • CRC Press

    (Publisher)

  Most commentators have stated that the mortgage crisis is a subprime crisis but as the delinquency figures suggest, the subprime area is only part of the story. All mortgages have been performing much worse, and adjustable rate mortgages (ARMs) and other nontraditional mortgages have been performing horribly whatever the creditworthiness of the mort-gagors. Rather than being confided to the Subprime Mortgage business, the events that led to the possibility of a crisis were generalized to all sectors of the mortgage industry and were compounded by people who FIGURE 5.2 Percentage of single-family mortgages in serious delinquency. (Data from Mortgage Bankers Association, Washington, DC; www.mbaa.org.) 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 0 5 10 15 20 25 30 35 40 Subprime FRM Subprime ARM Prime FRM Prime ARM FIGURE 5.3 Annual growth rate of U.S. home price index (percent). (Data from Standard and Poor’s, S&P/Case-Shiller Home Price Indices; http://www2. standardandpoors.com/portal/site/sp/en/us/page.topic/Indices csmahp/0,0,0,0,0, 0,0,0,0,1,3,0,0,0,0,0.html.) –20 –15 –10 –5 0 5 10 15 20 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 102 ◾ The Banking Crisis Handbook truly wished to stay in their home. In order to understand why, one needs to remember that since the mid-1980s, the U.S. economy had been expe-riencing a long period of stability with only two minor recessions. Thus, the financial community and the public progressively became used to rela-tively stable default rates and rising home prices, which had three major consequences. A first consequence was that financial institutions became willing to create complex financial products that involve higher leverage and that gave the impression that credit risk and liquidity risk can be managed more effi ciently than in the past. Securitization has been the main driver of those innovations that were extended progressively to more and more esoteric activities.

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  The Politics of Housing Booms and Busts

  • Leonard Seabrooke, H. Schwartz(Authors)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  At a price of course – banks charged higher interest rates to reflect the lack of documented income or a weak credit score. Banks carefully screened subprime bor- rowers precisely because they were bad credit risks whose defaults would land on banks’ own balance sheets. Moreover, an environment of gen- tly rising housing prices helped 1990s subprime borrowers to refinance themselves into lower interest rate mortgages after a few years. All this mitigated 1990s default rates for Subprime Mortgages. Origins and Consequences of the U.S. Subprime Crisis 199 The influx of new, effectively unmodeled subprime borrowers after 2003 rendered retrospective default models inaccurate, as did the end of house price appreciation. First, mortgage brokers rather than banks screened subprime borrowers. Brokers made money by originating mort- gages, not by holding them to term, and earned more money if a buyer could be lured into a large, high interest rate mortgage. With no credit risk, brokers had incentives to market as many dodgy mortgages as they could. Brokers made loans to otherwise uncreditworthy “NINJAs” who had “No Income, No Job and no Assets.” The historical data also did not capture a subtle shift from using subprime as an instrument for bor- rowers with damaged credit to using subprime and Alt-A for good credit borrowers who wanted to borrow much, much more than they could afford in order to buy the granite kitchen counter equipped McMansion that defined the “good life.” 1994 saw only $34 billion in subprime orig- inations, mostly through banks; 2004–06 subprime originations aver- aged over $600 billion annually, mostly through brokers and specialist lenders (Credit Suisse, 2007). The connection to the similar $600 billion jump in the ACBP market should be obvious.

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  Housing Market Challenges in Europe and the United States

  • P. Arestis, P. Mooslechner, P. Arestis, P. Mooslechner, Kenneth A. Loparo, Karin Wagner(Authors)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Prodded Philip Arestis and Elias Karakitsos 45 by policy makers, the housing finance industry is now racing to tap new markets for homeownership by reaching traditionally undeserved populations of racial and ethnic minorities, recent immigrants, Native Americans, and low- to moderate-income (LMI) households’ (Listokin et al., 2000, p. 19). The new financial innovation was based on the idea that the borrower and the lender can benefit from house price appreciation over short horizons, whereby the mortgage was rolled into another mortgage. The appreciation of housing becomes the basis of refinancing over short peri- ods of time. Borrowers thereby were able to finance and refinance their homes in view of the capital gains as a result of house price apprecia- tion. The appreciation enabled borrowers to turn it into collateral for new mortgages or extracting the equity for consumption. Lenders are also willing to lend to riskier borrowers. When prices of houses rise and the borrowers ‘extract equity’ through refinancing, lenders incorporate high fee prepayments to secure themselves. The main characteristic of a Subprime Mortgage market is that it is designed to force refinancing over a period of two to three years. Sub- prime mortgages are, thus, short term, thereby making refinancing important. But there is a prepayment penalty, whereby too early re- financing is undesirable. Most Subprime Mortgages are adjustable-rate mortgages, in that the interest rate is adjusted at a ‘reset’ date and rate, where the latter is significantly higher than the initial mortgage rate, but affordable (Gorton, 2008, p. 13). There is, thus, the incentive for the borrowers to refinance their mortgage before the ‘reset’ date. But the pre- payment penalty makes too early refinancing undesirable. 7 In fact, ‘no other consumer loan has the design feature that the borrower’s ability to repay is so sensitively linked to appreciation of an underlying asset’ (Gorton, 2008, p. 19).

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  Home Buying Kit For Dummies

  • Eric Tyson, Ray Brown(Authors)
  • 2020(Publication Date)
  • For Dummies

    (Publisher)

  In other words, they would have had to delay a desired home purchase until they upgraded their financial situation. Thanks to government backing and incentives, Subprime Mortgages mushroomed, and more renters were able to borrow money and purchase homes. As long as real estate prices continued rising, jobs were plentiful, and the economy was strong, things worked out fine. Unfortunately, during the mid-2000s, home prices began flattening, and then in the late 2000s prices started trending down, especially in those housing markets most heavily populated with subprime borrowers. On some of these loans, monthly mortgage pay -ments jumped significantly higher after an initial period, and borrowers couldn’t handle them financially. The economy soured, and layoffs and unemployment rose, which further pressured stretched homeowners. And as housing prices dropped more than 20 percent in particular markets, some of these subprime borrowers who bought with little or even no money down simply chose to walk away from homes worth quite a bit less than the outstanding mortgage balance. Real estate market downturns aren’t enjoyable for homeowners. No one likes to lose money, even on paper. And the late 2000s real estate market decline was a nasty decline for most parts of the country. But as with previous declines, this also passed. Home prices rose again. And lenders returned to more sensible lending criteria — expecting folks to make down payments and have decent credit or pay much, much more if they didn’t. 102 PART 2 Financing 101 On the other hand, adjustable-rate mortgages (ARMs for short) have an interest rate that varies (or adjusts ). The interest rate on an ARM typically adjusts every 6 to 12 months, but it may change as frequently as every month. As we discuss later in this chapter, the interest rate on an ARM is primarily deter -mined by what’s happening overall to interest rates.

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  Financial Boom and Gloom

  The Credit and Banking Crisis of 2007–2009 and Beyond

  • D. Chorafas(Author)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Analysts at Goldman Sachs reckon that credit card losses could reach billions, and practically all banks are exposed to credit card receivables. The credit crisis is also threatening to hit auto loans, and from there finance companies by way of car write-offs, as well as insurance firms. There are indeed many questions which remain to be answered about the subprimes crisis and its aftereffect, as by all likelihood what has been revealed in the third and fourth quarters of 2007 has been only the tip of the iceberg. Statistics are chilling. In the US alone, there are an estimated two million adjustable-rate Subprime Mortgages, due to be reset till mid 2009. They are worth a dazzling $350 billion, and ● They hang like Damocles’ sword over the global financial system. ● 14 These facts and figures are known to the authorities. In the week of 15 October 2007, Hank Paulson, the Treasury secretary, gave a strong warning that the slowdown in the US housing market and the concur- rent crisis in the credit and mortgage markets posed a significant risk to the American economy. He also pointed out that the problems did not stem only from the subprimes, or only from the millions of home- owners finding it difficult to make other types of mortgage payments. A combination of sliding house prices and loose lending standards for non-qualifying borrowers gave birth to a hydra whose killing needs a new Heracles. Not only did the aftereffect of the subprime crisis leave homeowners and investors nursing mounting losses, but also the mood of millions of borrowers changed greatly as they belatedly found that they were unable to make credit payments which became due. For the American public at large, a Fox News poll revealed that: 70 percent of respondents were against using taxpayer dollars to help ● out troubled homeowners, and 80 percent were against a bailout for banks, mortgage companies, ● and generally institutions that had created the subprimes mess.

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