REAL 236 Lecture 10 Slides_VFinal

REAL 236 Lecture 10 Slides_VFinal - Class 10 REAL/BEPP...

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Class 10 REAL/BEPP 236/836 International Housing Comparisons Prof. Susan Wachter MORTGAGE MARKETS AND SYSTEMIC RISK February 15, 2017
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Readings for Today Key Readings: Levitin and Wachter, Explaining the Housing Bubble , pp. 2-32 (Canvas) Acolin, Bricker, Calem, Wachter, Borrowing Constraints and Homeownership Skim: Levitin and Wachter, Housing Bubble , Ch. 2-3 Levitin and Wachter, The Public Option in Housing Finance (Canvas; SSRN Link ) Optional: Levitin and Wachter, The Commercial Real Estate Bubble (Optional; Canvas; SRRN Link )
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Next Class: Reminders/Readings Guest Speaker: Larry Cordell Cordell, Huang and Williams, Collateral Damage: Sizing and Assessing the Subprime CDO Crisis 3
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Affordability, risk and mortgage design Among countries with the same per capita income, some have a nonexistent or very small mortgage market? Why does this happen? Role of risks: interest rate, credit, and systemic Design mortgage instrument and housing finance system to contain
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Affordability, risk and mortgage design Lower risk to lender and thus to borrower, how? Lower annual payment to borrower, how? Lower credit risk to lender through underwriting guidelines
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Affordability v systemic risk trade-off Can reduce credit risk by tighter underwriting standards But affordability constraints increase
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The tilt effect of inflation Interest rate charged, i = r + p +f where r = riskless interest rate p = risk premium f = inflation premium Example: Suppose you take out a mortgage for $60,000 for 30 years at a fixed interest rate of 4% p.a. For now assume away prepayment risk, inflation risk and real interest rate risk, assume only a constant credit risk, p 7
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Affordability v systemic risk trade-off Can reduce credit risk by tighter underwriting standards But affordability constraints increase Can the system be made less risky? Reduce systemic risk? Housing finance system design
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Borrowing constraints Definition of constrained borrower: Would optimally owned but cannot due to lending constraints Example: Household Income= $50,000 Rent = $30,000 Ownership costs = $25,000 Owning costs less and has hedging and consumption smoothing advantages Why rent in this circumstance? 3 c’s constrain—eg DTY = 40%
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Brief History US Mortgage Markets: Review I. Depression Era to WW II II.1950s -70s III.1980s-2000 IV. 2000s
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Mortgages Before the Great Depression Short term (3-5 years) High downpayments Balloon payments Funded: Savings and Loans via deposits, Insurance Companies via Mortgage Bankers When unemployment spiked, could not refinance Banks unwilling to lend (FSLIC, FDIC had ended runs) Mortgage market collapsed
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FHA/VA, FNMA, and the “American Mortgage” Federal Housing Administration (FHA) created in 1934 to federally insure fixed-rate 30-year mortgages.
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  • Spring '17
  • Susan Wachter
  • Mortgage loan, Subprime mortgage crisis

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