The Mortgage Market Lecture

The Mortgage Market Lecture - Debt Instruments and Markets...

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Debt Instruments and Markets Professor Carpenter The Mortgage Market 1 The Mortgage Market Collateral, RMBS, CMBS, originator, service, FRM, ARM, GPM, balloon, PTI, LTV, FICO, prime, Alt-A, jumbo, subprime, pass-through, WAM, WAC, IO, PO, CMO, PAC, TAC, XS, OC, FHA, VA, GNMA, FNMA, FHLMC, private label, CDO, senior, subordinated, mezzanine, ABX, HPA, SPV, step-up rate Concepts and Buzzwords Mortgage lending Loan structures Loan quality Securitization Agencies/GSEs MBS The subprime story Readings Veronesi, Chapters 8 and 12 Tuckman, Chapter 21 Gorton, 2008, The Panic of 2007 Acharya, et al., 2010, Guaranteed to Fail
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Debt Instruments and Markets Professor Carpenter The Mortgage Market 2 Mortgage A mortgage is a loan secured by the collateral of some specific real estate property. The mortgage obliges the borrower (mortgagor) to make predetermined series of payments. The lender (mortgagee) has the right of foreclosure (can seize the property) if the mortgagor defaults. Typical Loan Structures Fixed-rate mortgage (FRM) – level monthly payments of principal and interest until maturity, typically 15 or 30 years. Adjustable-rate mortgage (ARM) – monthly payments based on a floating interest rate, adjusted periodically, according to a pre- determined interest rate index. It usually also has interest rate caps. Balloon mortgage – like FRM until balloon date when all principal comes due. Graduated payment mortgage (GPM) – monthly payments increase over time. Borrower has the option to pay the loan off early (prepay) at pre- specified terms.
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Debt Instruments and Markets Professor Carpenter The Mortgage Market 3 The Mortgage Market 1930s–1960s Before the crash of 1929, banks, S&Ls, and insurance companies originated and held residential mortgages. Then widespread defaults and foreclosures lead to thousands of bank and S&L failures. In 1932, Congress created the FHLB system of 12 regional banks that could borrow at favorable rates and lend to homeowners to facilitate household borrowing and promote home ownership. In 1934, the New Deal created the FHA to offer mortgage insurance on qualifying loans and FNMA to buy FHA-insured mortgages using money borrowed from capital markets in the form of Fannie Mae bonds, subsequently classed as “Agencies.” 1940s-60s: FNMA expanded to buy VA-insured loans and provide “special assistance” to certain kinds of mortgagors; enjoyed favorable tax status. Securitization – the 1970s 1968 – The Johnson administration privatized FNMA to get it off the government books, but FNMA retained special privileges. Also created GNMA (Ginnie Mae) inside HUD and FHLMC (Freddie Mac) inside the FHLB. These agencies were authorized to buy even non-insured loans from originators that met “conforming” size limit, guarantee them, pool them, and sell them to the broader investment community in the form of mortgage-backed securities (MBS).
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