Mortgage Crisis Flashcards

1
Q

What are the three key facts of the US mortgage crisis?

A
  1. Growth in mortgage credit, mostly to subprime borrowers
  2. Increase in securitization of subprime mortgages
  3. Growth in defaults for subprime borrowers
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2
Q

According to Mian & Sufi, what are three competing explanations for the expansion of subprime mortgages?

A
  1. Income-based hypothesis –> expansion was driven by better income prospects
  2. Supply-based hypothesis –> expansion was driven by outward shift in supply of credit by lenders
  3. House price expectation-based hypothesis –> expansion was driven by lenders’ increased expectations of the housing prices
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3
Q

How do we define a subprime borrower?

A

Consumer with a FICO credit score below 660.

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4
Q

What is a FICO credit score?

A

Credit rating by the analytics company FICO based on payment history, debt burden, length of credit history etc.

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5
Q

Who is the FHA and what do they do?

A

Federal Housing Administration
They provide mortgage loan insurance.

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6
Q

How does the fraction of subprime borrowers relate to income and credit growth?

A

Higher fraction of subprime borrowers leads to lower income.
Higher fraction of subprime borrowers leads to higher credit growth.

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7
Q

When comparing subprime to prime borrowers on growth rates and loan amounts, what can we see?

A

Growth rate of credit to subprime borrowers grew harder than for prime borrowers.
Amount of credit to subprime borrowers grew harder than for prime borrowers.

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8
Q

What was the result of the income-based hypothesis and does this explain the sharp increase in mortgage defaults?

A

Negative correlation between credit growth and income growth (for the first time in 18 years). This likely explains the sharp increase in mortgage defaults.

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9
Q

Perhaps, the increase in subprime mortgages was due to certain business cycle conditions. How can we measure that and what was the result?

A

Compare the subprime mortgage increase to another post-recession period. Stronger growth for the 2002-2005 period.

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10
Q

What does the supply-based hypothesis predict?

A

Can the growth in subprime mortgage credit be explained by a shift in credit supply?

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11
Q

How to check the supply-based hypothesis and what are its results?

A

Check the denial rate of mortgages
Check the securitization of subprime mortgages.
Check who they sold the MBS to.

The denial rate declined which means that more mortgages got accepted, which is in line with SBH.
Subprime mortgages where more securitized in that period, which is in line with SBH.
MBS were sold to securitized pools and noncommercial banks and not to commercial banks and affiliated investors.

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12
Q

Why were the mortgage-backed securities not sold to affiliated investors and commercial banks?

A

Because they had the ability to screen the investment and know it was a bad investment.

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13
Q

Was there an increase in housing prices before the crisis?

A

Yes

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14
Q

To check if the house expectation hypothesis holds, we should distinguish between two scenarios. Which ones?

A

Inelastic and elastic housing supply areas

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15
Q

What happens to an inelastic housing supply area when there is upward housing price pressure?

A

No new houses are built and the prices therefore increase

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16
Q

What happens to an elastic housing supply area when there is upward housing price pressure?

A

New houses are built and the prices remain constant because the demand it matched with supply

17
Q

How do we relate the result of elastic housing supply areas to the house expectation hypothesis?

A

The elastic housing supply area keeps the prices constant because new houses are being built and this is not in line with house expectation hypothesis who states that housing prices increase.

18
Q

Next to constant housing prices, what is another argument against the house expectation hypothesis?

A

If house price expectation hypothesis drives credit expansion, then in elastic housing supply areas, there should be no change in subprime mortgage credit growth, but there is!

19
Q

What is likely to explain the growth in housing prices?

A

Expansion of subprime mortgages driven by securitization.

20
Q

Describe how higher housing prices can create even higher housing prices through credit.

A

House price goes up, collateral goes up, credit availability goes up, house price goes up again.

21
Q

Describe lenders’ moral hazard in the light of securitization of subprime mortgages.

A

Incentives are not aligned. Lenders have no incentive to carefully screen loans they sell to investors.

22
Q

What is securitization?

A

Securitization converts illiquid assets into liquid securities.

23
Q

Name two benefits of securitization.

A

Improving risk sharing through MBS.
Reducing banks’ cost of capital.

24
Q
A