Subprime Mortgage Market: Rise, Fall, and Lessons for Korea

Abstract

The current study aims to provide an anatomy of the rise and fall of the subprime mortgage market in the US, by surveying the key economic and institutional determinants that have boosted the growth of the market since 2003 and those that have contributed to the abrupt decline since Summer 2007. To that end, a comparison is also made between the prime MBS (Mortgage Backed Security) market vs. the subprime MBS market, with respect to the collaterals used in the securitization, the MBS structure, and the risk management tools. The main issues focused in the survey are, among others, the excessive risk-layering by subprime mortgage lenders, the incentive problem caused by the nature of the off-balance sheet trades in both primary and secondary subprime mortgage markets, the convoluted securitization and hedging process, and the lack of basic risk measurement tools to support the rapid market expansion. Using the survey findings, several lessons and policy implications for the emerging mortgage market in Korea are discussed. Specific issues explored on that juncture, which are also put as future research issues, include mortgage product designs for borrowing-constrained households, different credit enhancement vehicles, and alternative modes of mortgage funding.