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MORTGAGES, MARKETS AND WHAT WE KNOW SO FAR Detroit Chapter of the Institute of Internal Auditors. Robert Van Order University of Michigan. Basic Observation: Big increase in foreclosures. Why?. Subprime ARM Defaults are Very Different from Prime and Subprime FRM. – Recession.

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mortgages markets and what we know so far detroit chapter of the institute of internal auditors

MORTGAGES, MARKETS AND WHAT WE KNOW SO FARDetroit Chapter of the Institute of Internal Auditors

Robert Van Order

University of Michigan

subprime arm defaults are very different from prime and subprime frm
Subprime ARM Defaults are Very Different from Prime and Subprime FRM

– Recession

Loans 90 days or more delinquent or in foreclosure (percent of number)

Subprime

ARM

Subprime

FRM

FHA & VA

Prime Conventional

Source: Mortgage Bankers Association

(Quarterly data not seasonally adjusted;1998Q1-2007Q3)

stylized facts and gatherings from various data sources
Stylized Facts and Gatherings from Various Data Sources
  • Credit Risk: A Few Propositions
  • Recent History: Especially Large Early Payment Defaults: Can it be rate adjustments?
  • Changing Loan Characteristics: Hard vs. Soft Data, Technical Change and the Two Decades.
  • Economic Conditions
  • Market Structure: The rise of subprime
  • Securitization: The rise of non-agency securities
slide5

2002 2003 2004 2005 2006 2007

Cumulative REO Rates Are Showing Poor Performance of Recent Origination VintagesCould it have been ARMs?

Alt-A

Subprime

Cumulative REO Rate as a Share of Number of Loans Originated

Age of Loan in Number of Months From Origination Date

Source: Loan Performance, a subsidiary of First American Real Estate Solutions

Note: the last twelve points on each origination year cohort contain fewer loans progressively as loans issued at earlier dates always age faster. Data through December 2008.

credit risk
Credit Risk
  • Underwriting models and history suggested scorecards and diversification worked
slide7
Relative Default ProbabilitiesNote the “Nonlinearity” as you move NortheastMore sensitive to mistakes.
slide9
So looking back, you would have thought that controlling FICO and LTV was a big deal, you couldn’t have a credit problem without changes in FICO-LTV distribution, and a diversified portfolio would perform well.
  • But Performance Got Really Bad.
  • Especially in Early Months
we seem to have two explanations left
We Seem To Have Two Explanations Left
  • Economic Conditions.
  • Structure and Moral Hazard
single family construction

– Recession

Single-family Construction

1- to 4-Family Housing Starts (thousands of units, SAAR)

Forecast

Third Quarter 2005 record: 1.8 million units

Fourth Quarter 2007:

0.9 million units

Sources: Bureau of Census, Freddie Mac

price changes by state third quarter 2007
Price Changes by State: Third Quarter 2007

United States -2.2%

(3rd Quarter Annualized Growth)

New England

-3.6%

Pacific -5.8%

Middle Atlantic

-0.9%

West North Central

-0.8%

Mountain

0.4%

East North

Central

-3.8%

DC

> 5% Quarterly Change

East South Central

-0.1%

0 – 5% Quarterly Change

South Atlantic -2.7%

< 0% Quarterly Change

West South Central

4.9%

< -5% Quarterly Change

Source: Freddie Mac Purchase-Only Conventional Mortgage Home Price Index (Annualized Quarterly Rates for 3rd Quarter 2007)

the structure of the market has changed
The structure of the Market Has Changed
  • More Subprime and Alt-A
  • Non Agency Securitization
slide20
Securitization ChangesNote the nonagency share went up after the subprime share went up and around the time the vintages got worse.
subprime securitization
SUBPRIME SECURITIZATION

Credit risk is more important than for Agency securities. The risk has been handled (poorly) by structuring.

So securitization could have been a big part of the problem, because it is so susceptible of moral hazard/asymmetric information.

Recall that to some extent the recent subprime loans didn’t look that bad on paper. Hard vs. soft information.

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