Subprime Mortgages And The Mortgage Crisis

Securitization Food Chain is the chain of loan payments for mortgage loans. The chain started with home buyers taking out a mortgage loan from lenders. After home buyers would take out a loan the lenders would then sell the mortgage to investment banks. The investment banks combined thousands such as car loans, student loans, credit card debt, and ect. The combination of all the loans was called Collateralized Debt Obligation. Investment banks take the Collateralized Debt Obligation and sell them to investors often misleading the investors to believe the investments where low risk. Risky investments were then made with the depositors money. They did not care about the quality of the mortgage, only maximizing their volume and getting a fee out of

Since mid 1990s, the subprime mortgage market has grown rapidly experiencing a phenomenal 23% compound annual growth rate to 2006. The total subprime loan originations increased from $65 billion in 1995 to $613 billion in 2006. The subprime sector has become a significant sub-sector of the total residential market accounting for 21% of all residential mortgage originations in 2006. Similarly, by year-end 2006, total outstanding balance of subprime loans grew to $1.2 trillion, approximately 12.6% of all outstanding mortgage debt.

The recent mortgage crisis in the US was unprecedented. It led to a massive clampdown of financial institutions, occasioning one of the worst financial melt-downs the US has ever faced (Jaffe, 2008). Quite naturally, it would be necessary to examine the cause of the crisis in order to draft prophylactic measures that would prevent the same financial disaster in the future. This paper will discuss the events that led to the mortgage crisis.

Rep. Barney Frank (D-MA) explains the old system of lending and the new securitization process. Matt Demon narrates how the home buyers repaid their loans to lenders, and consequently, the lenders sold the loans to the investment banks which combined the mortgage loans with other credit loans creating a collateral debt obligation a complex derivative. The collateral debt obligation sold to investors who paid the rating agency to evaluate the CDO's. The home buyers were now paying investors through this

The flow of funds within financial markets is stimulated by the money, bond and mortgage markets. A money market is the trading of highly liquid financial instruments with a duration of one year or less and includes the trading of Treasury bills. Furthermore, bonds are long term investments, with a duration greater than 1 year and are issued by corporations and the U.S. government. In addition, the mortgage market creates loans to finance the real estate market. Once mortgages are issued on a property, banking institutions securitize the mortgages and sell them on the secondary market (CSU Global, 2016). Due to the scale of these three markets they have an extensive impact on the monetary supply and economy.

Real estate finance in the modern community is changing the perspective of modern lending and purchases. It is a means to contemporary community’s ability to develop a foundation for discussing the nature and means of public spending and purchase. As a self-government sponsored agency, Federal National Mortgage Association (FNMA) also known as Fannie Mae works with the ultimate responsibility of lending and buying secondary mortgages in the market (Oesterle, 2010). It helps in the conservation of interest rates in the real estate business in the contemporary community. There is also the need for focusing on the impacts of the Fannie Mae on real estate finance. The approach of the Fannie Mae helps lenders to use the money gained from the secondary

"The Wall Street Journal" found that the current bond yields were 0.20. These bonds are issued by the US government. In view of the fact that Fannie Mae Securities is a mortgage-backed securities issued by FNMA. We have observed that Fannie Mae and Treasury yields are somewhat different because FNMA Personal Securities and Treasury bonds are issued by the US government. Therefore, we note that there should be some difference between the two rates. As a result, Fannie Mae gets money from investors and financial institutions and sells their mortgages.

Fannie Mae and Freddie Mac are government sponsored enterprises (GSE) that purchase mortgages, buy and sell mortgage-backed securities (MBS), and guarantee nearly half of the mortgages in the U.S. A variety of political and competitive pressures resulted in the GSEs ramping up their purchase and guarantee of risky mortgages in 2005 and 2006, just as the housing market was peaking.[258][259] Fannie and Freddie were both under political pressure to expand purchases of higher-risk affordable housing mortgage types, and under significant competitive pressure from large investment banks and mortgage

Fannie and Freddie remain two of the largest financial institutions in the world, responsible for a combined $5 trillion in mortgage assets. The primary function of Fannie Mae and Freddie Mac is to provide liquidity to the nation’s mortgage finance system. Fannie and Freddie purchase home loans made by private firms (provided the loans meet strict size, credit, and underwriting standards), package those loans into mortgage-backed securities, and guarantee the timely payment of principal and interest on those securities to outside investors. Fannie and Freddie also hold some home loans and mortgage securities in their own investment portfolios.

Mortgage-backed securities were bonds that were secured by home and other real estate loans. They were created when a number of these loans, usually with similar characteristics, were pooled together. As part of the housing and credit booms, the amount of financial agreements called mortgage-backed securities, which derive their value from mortgage payments and housing prices, greatly increased (Subprime mortgage crisis). Pools of loans were sold to federal government agencies like Ginnie Mae or a government sponsored-enterprise such as Fannie Mae or Freddie Mac. Securitization was the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security. A typical example of securitization

Securities: special vehicles issuing securities by mortgage of housing loan backed by a pool of asset.

This corporation was created not only to enhance the competition in the secondary mortgage market (Acharya, Richardson et al. 2011), but also to securitize mortgages, as Dodd (2007) mentions. The process of pooling mortgages and selling mortgage-backed securities (MBS) was developed, initially, by Ginnie Mae to reduce debt from the federal budget; the concept of securitization is discussed analytically later. The following years, MBS and securitization assisted GSEs to provide long-term funding in the US secondary mortgage market eliminating liquidity risk from originators while bearing both the credit and the interest rate risk (Dodd, 2007, Wall et al., 2005). The securitization could obliterate the interest rate risk from housing enterprises, as

According to Fligstein, the next step in market formation was crisis. In The Architecture of Markets he states, “market crisis is first observed when incumbent organizations begin to fail.” From 2007-2009, the housing market crashed as the value of homes in the US fell drastically. As a result, many homeowners began defaulting on their mortgages causing huge problems for those involved in the mortgage securitization market. On September 7th, 2008 when the Federal Housing Finance Agency (FHFA) place both Fannie Mae and Freddie Mac under government conservatorship. In addition, the US Department of Treasury agreed to inject up to $100 million into each GSE in order to provide liquidity and to continue purchasing mortgage-backed securities in the market. This would slow the US housing market’s downward spiral. In return, the government would be able to purchase 80% of Fannie Mae and Freddie Mac. The goal of these policy responses was to provide stability to the financial market and support the availability of mortgage finance.

Figure 1 shows the “Outstanding First-Lien Residential Mortgage Debt” in all sectors as of 2007. The “Agency Mortgage Backed Securities” represent the high credit, low loan-to-value, “safe” loans administered by governmental agencies such as; Fannie Mae, Freddie Mac and Ginnie Mae. The right side of the exhibit shows the “Non-Agency Backed Securities” which make up three areas of mortgage where the government is not willing to lend. Jumbo loans consist of those loans which exceed the maximum allowed loan limits which differ from state-to state. This level is set forth by the government and is any loan $417,000 or greater in North Carolina. The Alt-A loans are intended for those borrowers who do not fit in the conforming guidelines but who have a better credit rating and history than a sub-prime borrower. Alt-A loans would consist of loans for investment properties, second homes, or high loan-to-values for borrowers who would otherwise be considered conforming. The third section of this exhibit makes up the sub-prime borrowers who have less than stellar credit but are willing to pay a higher down-payment and a higher rate to get a mortgage loan. As you can see, the sub-prime sector makes up the majority of the non-agency loans. Also note that most of

The three financial markets, money, bonds and mortgage markets play a large role in the financial industry. Money markets are highly liquid investments that are held for one year or less, and include Treasury Bills. Furthermore, bonds are long term investments issued by corporations and the U.S. government and are held for more than one year. The mortgage market creates loans used to finance the real estate market, once mortgages are issued on a property, banking institutions securitize the mortgages and sell them on the secondary market (CSU Global, 2016). Therefore, these three financial markets are very broad in nature, which can cause a great impact on the financial market.