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Unformatted text preview: There also was dramatic growth in the fraction of loans that were interest only in all three major loan categories. For prime ARMs the fraction increased from 46% in 2002 to 91% in 2006, for Alt-A ARMs it increased from 26% to 87%, and for subprime ARMs the fraction increased from 1% to 20%. Moreover, the fraction of loans with full documentation (for example, income verification) declined by more than 10 percentage points in all ARM categories. These so-called NINJA (no income, no job, and no assets) or “liar” loans turned out to be just that: Loans with over-stated income or assets showed much larger loan delinquencies during the crisis. Finally, there was substantial growth in the average mortgage-payment-to-income ratio of households that held ARMs. In 2006, these averages were 37% for prime, 38% for Alt-A, and 42% for subprime ARM borrowers. A mortgage-payment-to-income ratio of 35% is considered high. The statistics for fixed-rate mortgage holders are similar, except that they had a smaller fraction of incomplete documentation loans. Loan quality continued to decline in 2007. According to a survey by the National Association of Realtors, the median down payment on home purchases was 9 percent in 2007, 38 down from 20 percent in 1989. Twenty-nine percent of buyers put no money down. And many borrowed more than the price of the home to cover closing costs. 3.3 King Kong Versus Godzilla While Freddie Mac had been securitizing mortgages since 1971 (and Fannie Mae since 1981), as explained in Chapter 1, private-label securitization did not start in earnest until the mid 1990s. As seen in Figure 3-1, in 1996, non-agency mortgage-backed securities (MBS) represented only 12% of all MBS originations. Their share grew dramatically from 17% in 2003 to 50% by 2006. In 2007, it fell back to 40%. Subprime mortgages were being securitized at a much higher rate than the average. In 2001, 50% of all subprime mortgages were securitized, while in 2006 this fraction had grown to 80%. Was the growth in private label MBS the culmination of the dream of the deregulation advocates of the 1980s coming to fruition, albeit two decades later? Or was it the emergence of new government-sponsored enterprises in the form of too-big-to-fail financial institutions? We argue the latter, and, with this emergence, came a battle between the GSEs and the too-big-to- fail large complex financial institutions (LCFIs), and a race to the bottom in mortgage finance. We argued in chapter 1 that no private firm could compete with Fannie and Freddie because of Fannie and Freddie’s access to government guaranteed capital. So how did the competitive race to the bottom play out till it all ended? One way that the private sector started competing was through moving down the credit curve of increasingly shaky mortgage loans -- loans that were difficult for Fannie and Freddie to compete with, given their “conforming loan” underwriting standards. But this is not the whole story, as it still does not explain why anyone underwriting standards....
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