REAL 236 Lecture 10 Slides_VFinal

Business 2 securitization mbs insurance paid for by

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Business 2: Securitization (MBS), insurance paid for by guarantee fees (g-fees) How do these operate? Business 1: Corporate debt which funds mortgages retained on the institutions’ balance sheets (which are mainly composed of mortgages) Business 2: Securitization represents pooling of mortgages and issuing securities (MBS) against these pools. The MBS serve as “pass-through entities” by which the cash flows of the mortgage pool pass through to investors.
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How Do These Lines Make Money? Business 1: Issuance of corporate debt to fund mortgages Make money by charging for credit risk By taking on interest rate risk (Investors in corporate debt have certainty on maturity date) Business 2: Securitization; Insurance (G-fees) Insurance: Make money from spread between g- fees and actual losses (Investors in this line of business face interest rate risk)
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2000s: Bubble and bust 47 3c
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The 2000s—Private Label Securitization Takes off Refi boom in 2000/ Greenspan “put” Refi a Wall St bonanza through 2003 Slows in 2003-4 as interest rates level out Subprime grows and sharply expands in 2003 Leverage explodes from 2003 through 2006 48
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U.S. Residential Mortgage Market Overview Recent Past Banks Borrower Mortgage bankers Money managers Insurers Banks/ Thrifts Agencies Thrifts Other investors Servicers Brokers/ dealers Origination Servicing Securitization Distribution 49
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Banks Borrower Mortgage bankers Money managers Insurers Banks/ Thrifts Private conduits Agencies Thrifts Other investors Servicers Brokers/ dealers Origination Servicing Securitization Distribution U.S. Residential Mortgage Market Overview Historic and Current 50
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Interest Rates Bottom in 2003
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Private-Label Securities: 2003-07 AMIs niche product and PLS niche securities Explosion 2003-7 of risk products negative amortization, pay option ARMs, balloons, Alt-A And risk securities CDOs, CDOs squared, Credit Default Swaps 53
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Subprime Markets: historically a niche High credit risk (low FICO scores) Spreads: 300-600 bp Why did subprime markets grow? As subprime markets grew, how did they change? Subprime as of 2001 Leverage as a % of GNP overtime 54
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Non Agency Share of MBS market rapidly expands from 2002 - 2006 56
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Mortgage leverage grows Source: U.S. Federal Reserve, Bureau of Economic Analysis Sectoral contribution to U.S. gross debt Percentage of GDP Nonfinancial Companies Financial Companies Household Government 57
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58 Non-Prime Grows from 15% to 46% of the Market from 2002 to 2006
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Risk Products 59
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Market Share of Nontraditional Mortgage Products and Private Label Securitization 60
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61 Lending Spreads Declined, 2002 to 2006 Spreads declined
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Information Failure: The Mispricing of Risk Financial intermediaries lowered PLS yields, despite the increasing default risk of the mortgage pools: These rates were calculated after the market collapse.
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  • Spring '17
  • Susan Wachter
  • Mortgage loan, Subprime mortgage crisis

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