paper about MBS

This effectively constitutes a foray into jumbo

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Unformatted text preview: This effectively constitutes a foray into jumbo lending for the GSEs. Therefore, under the conforming mortgage proposals, almost 50% of the market would currently be precluded from any type of refinancing, thus increasing their mortgage costs and putting even greater pressure on the housing market. One advantage of extending the hybrid market to non-conforming loans is that it may help to revitalize, or at least protect, the non-prime mortgage market, which has been anemic since the start of the financial crisis in 2007. The second, and main, advantage of such extension 121 is that the government would receive compensation for the systematic credit risk that resides in non-conforming mortgages and which it ultimately bears anyway. As in the 2007-09 crisis, most of that default risk in the event of a major housing crisis is, in fact, concentrated in the non- prime mortgage segment. Obviously, the price for guaranteeing the credit risk of such non-conforming mortgages will be substantially higher than for conforming mortgages. Because the co-insurance scheme should not involve any government subsidy, it may well turn out that the market price for this insurance proves prohibitively high so that (the riskiest) non-conforming mortgages are held by the banking sector or securitized in the private-label mortgage backed securities (PLS) market without guarantees. However, if the private market sets the wrong insurance prices, the consequences are much more severe in terms of the moral hazard impact given the government involvement and given the highly risky nature of underlying mortgages. In fact, it may well not be desirable for society to stimulate non-core mortgage lending in any way or shape, as it may lead to a repeat of the excessive credit extension of the housing boom in 2000-2006. For these reasons, we do not feel that the public-private partnership is a viable option for the nonconforming mortgage market. 59 The question is what alternatives exist for the nonconforming mortgage market? While some guarantees might be necessary initially to restore the mortgage market, it is clear to us that these guarantees should be focused on tightly underwritten core mortgages with the eventual goal of the government substantially reducing its role in mortgage finance. It seems that any proposal that would have the US government co- insure all of the mortgage credit risk in the US, or even all of the tail risk, would lead to an even bigger catastrophe than the one we just had. The only option appears to be the development, and most likely a slow one, of a private sector mortgage lending market for nonconforming mortgages. This market in theory would consider and price in the loan’s LTV, FICO score, the borrower’s income to mortgage interest ratio, as well as intangible information. Like other countries, it may well be that this market is not securitized, and loans would be held on the balance sheet of financial institutions as whole loans. It may be, however, that simpler, more standardized structured finance products develop loans....
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This effectively constitutes a foray into jumbo lending for...

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