Overview of the Subprime Mortgage Crisis
Steve Westley
U.S. Government Accountability Office
Financial Markets and Community Investment
westleys@gao.gov
Presentation at the Hudson Institute
October 24, 2007
1
Objectives
• Analyze the scope and magnitude of recent trends in home
mortgage defaults and foreclosures, and how these trends
compare with historical values.
• Evaluate developments in economic conditions and the
primary and secondary mortgage markets associated with
recent default and foreclosure trends.
2
Background
Note: Data exclude home equity loans.
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Background
Market Shares of the Minority Submarket for Hom e Purchase Mortgages
( in terms of number of loans)
Note: Percentages are for first-lien mortgages to owner-occupants.
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Default and Foreclosure Trends
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Default and Foreclosure Trends
Note: The MBA data do not separately identify Alt-A loans but include them in the prime and subprime categories.
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Default and Foreclosure Trends
(Q2 2005 – Q2 2007)
Note: Figures exclude government-insured or -guaranteed loans because they did not contribute to increases during the period ex amined.
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Default and Foreclosure Trends
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Default and Foreclosure Trends
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Default and Foreclosure Trends
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Developments Associated with Recent Trends
• A combination of economic and market developments contributed
to recent default and foreclosure trends, including:
• the rapid decrease in home price appreciation throughout much
of the nation beginning in 2005 and weak labor market
conditions in certain states;
• aggressive lending practices that reduced the likelihood that
some borrowers would be able to meet their mortgage
obligations; and
• growth in the private mortgage-backed securities market, which
provided liquidity to support these lending practices.
• Other developments may have played a role, but additional
information would be needed to fully assess their impact.
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Developments Associated with Recent Trends
Decline in House Price Appreciation
Note: The HPI ratio is the ratio of (1) the projected OFHEO house price index for purchase transactions, assuming average Q3 2003 – Q1 2006 appreciation continued
through Q2 2007 to (2) the actual OFHEO house price index as of Q2 2007. The figure covers the 25 states with the highest HPI ratio.
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Developments Associated with Recent Trends
Weak Regional Labor Market Conditions
• Parts of the industrial midwest have experienced job losses,
particularly in the manufacturing sector.
• Michigan’s rate of non-farm employment growth was -4.6
percent from the fourth quarter of 2001 through the second
quarter of 2007.
• The corresponding figure for Ohio was -0.9 percent.
• From the second quarter of 2005 through the second quarter of
2007,
• Michigan had the third largest increase in the total number of
foreclosure starts (behind California and Florida).
• Ohio had sixth largest increase in the total number of
foreclosure starts.
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Developments Associated with Recent Trends
Easing of Underwriting Standards and Wider Use of Certain Loan Features
Note: Loan characteristics are f or mortgages originated in the y ear indicated and pooled into priv ate label securities. The CLTV f igure ref lects purchase loans only , while the piggy back loan f igure
ref lects both purchase and ref inance loans. The percentages in the f igure on piggy back loans represent the dollar amount of f irst-lien mortgages with an associated piggy back loan. In dollar terms,
jumbo, Alt-A, and subprime mortgages represented about 19, 16, and 24 percent of mortgage originations in 2006 (excluding home equity loans), respectiv ely .
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Developments Associated with Recent Trends
Easing of Underwriting Standards and Wider Use of Certain Loan Features
Note: Percentages represent the dollar amount of purchase and refinance mortgages originated in the year indicated and poole d into private label
securities that have certain characteristics. In dollar terms, jumbo, Alt-A, and subprime mortgages represented about 19, 16, and 24 percent of mortgage
originations in 2006 (excluding home equity loans), respectively.
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Developments Associated with Recent Trends
Easing of Underwriting Standards and Wider Use of Certain Loan Features
Note: Percentages represent the dollar amount of purchase and refinance mortgages originated in the year indicated and pooled into private
label securities that have certain characteristics. In dollar terms, jumbo, Alt-A, and subprime mortgages represented about 19, 16, and 24
percent of mortgage originations in 2006 (excluding home equity loans), respectively.
16
Developments Associated with Recent Trends
Easing of Underwriting Standards and Wider Use of Certain Loan Features
Note: Percentages represent the dollar amount of purchase and refinance mortgages originated in the year indicated and pooled into private label
securities that have certain characteristics. In dollar terms, jumbo, Alt-A, and subprime mortgages represented about 19, 16, and 24 percent of
mortgage originations in 2006 (excluding home equity loans), respectively.
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Developments Associated with Recent Trends
Easing of Underwriting Standards and Wider Use of Certain Loan Features
• FitchRatings analysis of securitized subprime loans from 2005 shows the impact of
risk layering on mortgage delinquency rates after 1 year of seasoning.
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Developments Associated with Recent Trends
Growth in Private Label RMBS Market
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Developments Associated with Recent Trends
Growth in Private Label RMBS Market
• Role of investment banks and credit rating agencies
• Officials acknowledged that they were surprised by the speed and severity
of declines in house price appreciation and had underestimated the risks
of certain loan features such as low documentation and high LTV ratios.
• Recent credit rating downgrades for RMBS have affected a relatively small
portion of total private label RMBS issuances and have largely been
limited to lower-rated securities.
• However, downgrades of second-lien subprime RMBS have been more
extensive—for example, Moody’s has downgraded about 60 percent of the
dollar volume of these types of securities that it rated in 2006.
• Rating downgrades introduced uncertainty about the credit quality of
subprime RMBS, contributing to financial market disruptions that reduced
liquidity for borrowers seeking to refinance out of loans at risk of default or
foreclosure
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Developments Associated with Recent Trends
Other Possible Factors
• Misaligned incentives and lack of accountability in the
origination and distribution of mortgages
• Originators had financial incentives to increase loan
volume, potentially at the expense of loan quality.
• In 2005, brokers accounted for about 60 percent of
originations in the subprime market (compared with
about 25 percent in the prime market).
• Some originators, particularly independent mortgage
companies, lacked sufficient capital to make good on
representations and warranties.
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Developments Associated with Recent Trends
Other Possible Factors
• Federal regulation of
lenders Top 25 Originators of Subprime and Alt-A Loans in 2006
• In prior work, GAO
raised concerns about
nonbank lenders, noting
that some have been
targets of some of the
most notable federal
and state enforcement
actions involving
abusive lending.
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Developments Associated with Recent Trends
Other Possible Factors
• Mortgage fraud Suspicious Activity Report Submissions Citing Mortgage Fraud
• According to some
industry researchers,
growth in early payment
defaults in recent years
(i.e., defaults occurring
within a few months of
loan origination) are an
indicator of increasing
mortgage fraud.
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