BA 572 presents:

The Subprime Mortgage Lending Market

by Ofer HeymanMay 11, 2011

Agenda (interruptions welcome)

• Understand it!– Mortgage and MBS context– What is subprime loan?– Criteria / Grading– History

• The 2007 Subprime Meltdown– Introduction– Personal perspective– By the numbers– Broader effects– Myths and Conclusion

Mortgages

• Risk free? / Poor investment?Investor view point!

• Securities (g)

Subprime Loans - Basics

• What is it?– Lower than prime rate? Bad people?– Discretization (bb)

• Major Criteria for Grade A– FICO > 660– PTI < 0.28 / 0.36 (bb)– LTV < 0.95 (bb)Varies in practice– A-/B…/D

Subprime Loans - Basics

Subprime Loans - Basics

Subprime Loans - Basics

• Size proportion (g)

Subprime Loans - History

• Milestones leading to the 2007 crisis– 1980: Allowing high rates (DIDMCA)– 1982: Permitting variable rates and balloons (AMTPA)– 1986: Tax Reform Act - prohibited other deductions– 1995: MBS with subprime-loan collateral more attractive– Late 1990s : rapid growth of highest risk

• Also, dropped rates cash out

– 2000-2005: rapid growth in volume, mainly lower risk– 2005-2006: The bubble grows– 2006-2007: Bubble bursts, increased rates defaults– 2007-2008: MBS crash

The Subprime Crisis

The Subprime Crisis

The Subprime Crisis

The Subprime Crisis

The Crisis – broader effect

The Crisis – broader effect

The Subprime Crisis

• Myths– Subprime went only to impaired borrowers– Subprime promoted home ownership– Decline in home value CAUSED the crisis– Subprime mortgages failed because of rate resets– Crisis was unexpected– Subprime market was too small to cause big troubles

– Complex system– Boom-Bust classic

Main Sources• Videos

– http://www.youtube.com/watch?v=HSjEyOp2dEM&feature=related– http://www.youtube.com/watch?v=q8hjUei-Nwo

• Papers and Web Sites– Ten Myths about Subprime Mortgages (May 9, 2009):

http://www.clevelandfed.org/research/commentary/2009/0509.pdf– A Snapshot of Mortgage Conditions with an Emphasis on Subprime Mortgage

Performance (August 27, 2008): http://www.federalreserveonline.org/pdf/mf_knowledge_snapshot-082708.pdf

– Wikipedia: http://en.wikipedia.org/wiki/Subprime_mortgage_crisis– The Evolution of the Subprime Mortgage Market (Feb 2006):

http://research.stlouisfed.org/publications/review/06/01/ChomPennCross.pdf