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					 Javier Gonzalez
Anne Marie Gruber
   Jason Wyatt
  Miguel Zuniga
   For most people, their primary financial asset
    is the equity in their home
   US mortgage debt as a percentage of total
    household income:
    ◦ 1949: 20%
    ◦ 2001: 73%
   Mortgage debt as a percentage of total
    household assets:
    ◦ 1949: 15%
    ◦ 2001: 41%
   Subprime lending refers to borrowers who
    have limited income, poor credit history, or a
    combination of both
   FICO credit scores range from 300 to 850
    ◦ Subprime borrowers: 620 and below
    ◦ Prime borrowers: 621 to 850
   The lower the FICO score, the higher the
    interest rate, and vice-versa
   Majority of people in the US are considered
    subprime borrowers
   Mortgages in the 1930s
    ◦ Variable interest rates
    ◦ Maturities ranging from 5 – 10 years
    ◦ High down payment
    ◦ Low loan-to-value ratios of 50% or less
    ◦ Some borrowers relied on refinancing at the end of
      the term in order to pay off their outstanding
      balance
    ◦ Other borrowers renegotiated their contracts at the
      end of every year
   Property values in the US fell by 50%
   At the end of the Great Depression, 10% of
    homes in the US were in foreclosure
   250,000 foreclosures per-year from 1931 -
    1935
   Federal Housing Administration (FHA)
   Long-term, self-amortizing home loan
   Federal National Mortgage Association
    (FNMA)
   Federal Home Loan Banks system
   The supervisory Federal Deposit Insurance
    Corporation (FDIC)

   Percentage of homeowners increased from
    44% to 66% and no notable scandals
   1968 FNMA rebranded as Fannie Mae to
    remove it from the government books in
    hopes that a private corporation would
    provide more liquidity for mortgages
   1980s
   Savings and Loans allowed to “speculate in
    far-flung ventures with no connection to their
    core mission of providing mortgages”

   Result
    ◦ A cost of more than $200 million to taxpayers
      because of loan defaults and bankruptcies
   Late 1990s and early 2000s
    ◦ Securitization
      Delayed, removed, or minimized the effects of poor
       lending decisions by organizations making loans
      Facilitated the process for lenders to use inappropriate
       loan procedures, underwriting standards, and products
       with borrowers
      Allowed lenders to stress quantity over quality
   Deregulation
   Federal Reserve decreased interest rates to
    extremely low levels
   Real estate appreciating at high rates
    ◦ In 2004, home prices increased by one of the
      fastest rates in decades – 4 ½ times as quickly as
      inflation
   “2-28”, fixed rate for two years and after the
    initial two year period it would convert to a
    variable rate for the remaining 28 years
   “3-27”, which is initially fixed for three years
    and then converts to variable for the
    remaining 27 years
   Sometimes referred to as “bait and switch
    method”
   Approximately $67 billion of these loans have
    defaulted before the variable rate has even
    taken effect
   First acknowledgement of problem in the
    subprime market
   Two hedge funds run by Bear Stearns failed
    due to unprecedented declines
   Value of dollar declined
   Swap spreads reached their highest point
    since 2003
   Credit derivatives began to drawback
   Investors believed the problem was limited to
    a small number of lenders
    ◦ Since late 2006, 189 major US lending operations
      have imploded – up from 97 on July 17, 2007
   Believed that defaults would be limited to
    states located in the Midwest
    ◦ Crisis has spread to heavily populated states like
      California and Florida
   The way mortgages have been repackaged
    and sold
    ◦ Initially bundled into residential mortgage-
      backed securities (RMBS)
       In 2000, $738 billion RMBS
       By 2006, $2.4 trillion
    ◦ RMBS’s than were separated and placed in
      collateralized debt obligations (CDO)
   These tranches had very high returns but also
    were the most risky because they were the
    first to suffer if the underlying bonds default
   Fear of Fraud
   Basel 2 regulations on bank capital
   Evaporation of liquidity

   The rating agency Moody’s downgraded 399
    of these RMBSs
   Standard & Poor’s to downgrade some 612
    bonds worth $12 Billion
   “2-28” and “3-27” ARMs are ending their
    initial fixed periods and beginning in 2008
    will reset to the higher rates
   More than two million subprime borrowers
    are facing higher mortgage costs and the
    possibility of losing their homes
   This one driven by greed
   Deregulation
   Banks figured out how to develop subsidiary
    companies that did not have to follow the
    same regulation guidelines as they did
   Most of the largest mortgage companies in
    operation are subsidiaries of banks
   Profits are directly linked to volume of loans
   Relaxed their credit standards way beyond
    the point of recklessness simply because
    they understood their ability to pass the
    risk on to other investors
   Mortgages were offered without thorough
    income verification, no down payments, and
    low “teaser” rates which became unaffordable
    once they rose to the market rate
   Increased subprime lending has been associated
    with higher levels of delinquency, foreclosure,
    and abusive lending practices
   October 2006 to October 2007
    ◦ 224,451 home foreclosure filings
    ◦ a 94% increase from October 2006
   In each quarter of 2008
    ◦ approximated 450,000 subprime borrowers will
      experience mortgage payment increases
    ◦ as many as 500,000 of these could lose their homes
.
   Treasury Department announced a plan
    involving mortgage industry leaders which could
    potentially save struggling homeowners from
    foreclosure by freezing interest rates on
    subprime mortgages for up to seven years
   One area of concern is that questions still
    remain over how to avoid investor lawsuits and
    other legal challenges
    ◦ Investors were promised a certain yield, based on the
      expected hikes in interest rates, and an automatic
      freeze without reviewing individual loans may give
      them grounds to sue mortgage servicers
   In a sense, the market is merely correcting itself.
   Lenders have receded back to their original strict
    lending standards
   Many of the lending institutions who were largely
    responsible for much of the questionable lending
    that took place in the subprime market have
    gone or will go bankrupt
   However, the reality is that millions of Americans
    may still lose their homes and the effects on the
    broader economy may be shocking

				
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posted:3/9/2011
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