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How the Securitized Mortgage Market Imploded.

How the Securitized Mortgage Market Imploded. Phillip Millman. Answer:. Everyone was complicit from borrowers to investors, Weak oversight, Complicated Impossible to value products, Leverage, Leverage, Leverage, And Leverage,. Simple Agency MBS (Pass Through).

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How the Securitized Mortgage Market Imploded.

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  1. How the Securitized Mortgage Market Imploded. Phillip Millman

  2. Answer: • Everyone was complicit from borrowers to investors, • Weak oversight, • Complicated Impossible to value products, • Leverage, • Leverage, • Leverage, • And • Leverage,

  3. Simple Agency MBS (Pass Through) • Typically found in Fannie Mae Pools and Freddie Mac PCs • The majority of issuance except for 2005 to mid 2007. • Now it’s the only game in town. • Loans are guaranteed by the GSEs and sold to investors. • Very high quality loans • Loan-to-value <= 80% • Credit Scores > 720 (mostly) • Debt-to-Income (DTI) Ratio < 32% • Full verification of Asset and Income • Loan balance < $417k (as of 1/1/09). This limit changes annually. • Can be sold forward (known as TBA)

  4. Collateralized Mortgage Obligations (CMO) • Structured deals with multiple securities called tranches. • Agency Pass Thrus are used as collateral for prepayment sliced bonds. • E.g. PAC, TAC, VADM, IO, PO, and etc. • The GSE guarantee of the underlying pools/PC carries through. • However, non-Agency pools need to have their own insurance or principal protection. • Also known as real estate mortgage investment conduit (REMIC).

  5. Non-Agency REMIC • The senior subordinate structure created by Wall Street and blessed by the rating agencies created self-insuring structures. • Senior Subordinate Structure is the most common.

  6. Subprime & Alt-A MBS • Originators and Wall Street with Rating Agency blessings used the senior/sub structure to securitize loans that could not go into Agency pass thrus. • Subprime mortgages (~$1.5 trillion outstanding). • FICOs < 640 • Combined LTVs > 80% • Tend to be lower balance. • Alt-A mortgages (~$600 billion outstanding) • No or limited documentation (NINA, SISA or liar loans) • Investor loans • Option ARM or MTA loans!

  7. Leverage • Collateralized Debt Obligation (CDO) managers bought A/BBB rated tranches and repackaged (through a REMIC) them to create 75% AAA. • Pure ratings arbitrage with full blessings from rating agencies. • Crap in – Crap out. • Nearly impossible to value • Credit Default Swaps • Subprime & Alt-A • ABX Index • Leverage 150(?) to one.

  8. Impairments • Accounting rules require a mark-to-market writedown even if losses are expected to be $1. • Many (not Option ARM) originally rated “AAA” bonds are expected to take minimal losses. • For example a security that was originally priced at par (100) is now priced at 35. If the expect loss is 5 pts, the loss through earnings is 65 pts!

  9. Questions

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