Subprime Mortgage Defaults Research Articles

Problems in the Governance of Financial Companies and whether Current Corporate Regulation Can Prevent the Recurrence of Financial Crises

During the financial crisis of 2008, global economics experienced an immense impact and the majority of the financial firms were affected a lot. In the aftermath of the crisis, experts have analyzed the major problems that emerged in the management of financial companies during the financial crisis, and have solved these problems. However, the outbreak of the financial crisis has a variety of causes, such as war, and disaster. A lot of the blame has been placed on subprime mortgage defaults. But the fact is that the bad loans of the bank existed for a long time. Contrary to common belief, the primary cause of the crisis was not subprime mortgage defaults, but rather a lack of corporate governance, according to the Association of Chartered Certified Accountants. Therefore, this paper analyses one of the reasons is the problems of financial companies in management, and the paper is divided into specific problems, solutions, contrast and conclusion to go over my point of view that the poor management of financial companies led to the 2008 financial crisis.

Spatial Dependence in Subprime Mortgage Defaults

We analyze the spatial default dependence between pairs of nonconforming securitized mortgages, originated in Los Angeles between 2000 and 2011 and clustered by zip code. Our approach allows us to estimate the range and shape of the spatial dependence function, which relates zip-code center-to-center distance between mortgages to the dependence parameter of a number of different copulas. We find significant evidence for the presence of spatial dependence, which decays to zero within 40km and can be well characterized by a squared exponential function, a special case of the Matern spatial correlation function.

Subprime Mortgage Default in Minority Neighborhoods

In this paper, we empirically examine differences in subprime borrower default decisions by Census tract characteristics in order to clarify how the subprime foreclosure crisis played out in minority areas. An innovation in our modeling approach is that we do not constrain the impact of neighborhood composition to be identical across diverse decision-making settings. Rather, we focus on variation in decision-making when the option to default is more likely to be in the money. Carefully controlling for dynamic loan balances and home values, as well as other loan characteristics and economic conditions, we find that borrowers in minority neighborhoods, delineated by Census tracts, were less likely to default at high contemporaneous, combined loan to value ratios (CLTV) than those in neighborhoods with fewer minorities. Borrowers in tracts with a greater share of recent immigrants where overall mobility is greater are more likely to default at high CLTVs, however. Our finding that subprime borrowers in minority neighborhoods have a lower propensity to default at high CLTV stands in contrast to assertions that households in these neighborhoods may have been more willing to strategically default, that is, to default when equity turned negative regardless of their ability to repay. By contrast, our findings show that borrowers in white neighborhoods were more likely to default when they had relatively higher negative equity.

Asymmetric Information and Subprime Mortgage Default

Using a novel data set, we study the soft information in subprime mortgages that is not verifiable by a third party, and its relationship with mortgage default. We find that lender effort to collect soft information is intertwined with borrower self-selection into subprime mortgages. We employ various sample stratification strategies to distinguish between two explanations, where one is more evident in some subsamples than is the other. Our results support that soft information is more evident in low-competition markets and among borrowers with low credit score, while adverse selection is more applicable to liquidity-constrained borrowers and loans originated by brokers. Both explanations are reflected in low-documentation loans, since lenders must expend greater effort collecting soft information, and borrowers have more private information to adversely select. The development and expansion of securitization has diminished soft information while increasing borrower adverse selection opportunities.

Why Did So Many Subprime Borrowers Default During the Crisis: Loose Credit or Plummeting Prices?

The surge in subprime mortgage defaults during the Great Recession triggered trillions of dollars of losses in the financial sector and accounted for more than 50% of foreclosures at the height of the crisis. In particular, subprime mortgages originated in 2006-2007 were three times more likely to default within three years than mortgages originated in 2003-2004. In the ensuing years of debate, many have argued that this pattern across cohorts represents a deterioration in lending standards over time. I confirm this important channel empirically and quantify the relative importance of an alternative hypothesis: later cohorts defaulted at higher rates in large part because house price declines left them more likely to have negative equity. Using comprehensive loan-level data that includes much of the recovery period, I find that changing borrower and loan characteristics can explain up to 40% of the difference in cohort default rates, with the remaining heterogeneity across cohorts caused by local house-price declines. To account for the endogeneity of prices — especially that price declines themselves could have been caused by subprime lending — I instrument for house price changes with long-run regional variation in house-price cyclicality. Control-function results confirm that price declines unrelated to the credit expansion causally explain the majority of the disparity in cohort performance. Counterfactual simulations show that if 2006 borrowers had faced the price paths that the average 2003 borrower did, their annual default rate would have dropped from 12% to 5.6%.

Subprime Mortgage Defaults and Credit Default Swaps

Subprime Mortgage Defaults and Credit Default Swaps

The future of corporate governance: Network governance - a lesson from the financial crisis

Abstract 10.2 trillion dollars have been lost in the US alone in the first two years after Lehman Brothers collapse. In its wake 45% of world’s wealth has been destroyed and three of the largest bankruptcies in the US have occurred. Just as the majority of observers thought lessons from Enron had been learned, crisis had struck again. Massive government intervention, the collapse of the banking system, and public outrage at the missteps of executives have highlighted once more the weaknesses of mainstream corporate governance systems. Contrary to popular opinion the principal cause of the crisis was not sub-prime mortgage defaults but a failure of corporate governance, states the Association of Chartered Certified Accountants. While the OECD is brainstorming new corporate governance codes, public policy makers are calling for more comprehensive and tougher regulation. How likely will those changes help to prevent a future crisis? Not very likely, we argue, unless we fundamentally rethink the underlying failures inherent to the Anglo- Saxon structure of corporate governance and regulation. In the following article, we thus examine the systemic shortcomings of Anglo-Saxon corporate governance that arise from too much power being vested in a single board. We also lay out alternative governance models based on the natural science of communication and control. We then identify why a single board cannot adequately and reliably control the complex firms that wield influence over our lives. Examples of alternative models provide evidence that managers can design governance architectures that significantly reduce the risk of systematic blind spots, and the ensuing massive wealth destruction.

Subprime Mortgage Defaults and Credit Default Swaps

ABSTRACTWe offer the first empirical evidence on the adverse effect of credit default swap (CDS) coverage on subprime mortgage defaults. Using a large database of privately securitized mortgages, we find that higher defaults concentrate in mortgage pools with concurrent CDS coverage, and within these pools the loans originated after or shortly before the start of CDS coverage have an even higher delinquency rate. The results are robust across zip code and origination quarter cohorts. Overall, we show that CDS coverage helped drive higher mortgage defaults during the financial crisis.

Subprime Mortgage Delinquency and Default Rates by Metropolitan Area: An Analysis by Origination Vintages and Projections for 2007

Subprime mortgage default rates have led to a crisis in the residential mortgage markets unprecedented since the Great Depression. Information reported on these defaults has demonstrated that they vary by location and region. To properly understand the causes of such high rates of mortgage defaults, we undertook this study. It reports on a cross-section analysis of default rates of residential, subprime and Alt-A mortgages aggregated to the metropolitan areas (MSA) level. The hypotheses tested here represent the effects of loan and borrower level characteristics and MSA economic factors, such as MSA employment growth, unemployment rate, household income and housing price changes and their volatility on the level of default rates on subprime mortgages. We test these by origination vintage for 2005 and 2006 and project default rates by MSA into 2007 using 2006 vintage estimated parameters. We find that loan and borrower level characteristics such as loan-to-value ratio weighted by original loan balances, the weighted proportion of loans that have no documentation or the borrowers’ weighted FICO score and MSA economic factors of housing price changes and employment growth are highly statistically significant and economically important in explaining MSA subpirme residential mortgage default rates over the 359 MSAs for 2005 and 2006 vintages. The data used are from Loan Performance data base for 6 million subprime loans separated into 2005 and 2006 vintages, the OFHEO (now FHFA) Housing Price Index and household employment Dept. of Labor. Projections of housing price changes and employment growth for each MSA were used based on a linear extrapolation of the past 9 months of 2006 and the first 3 months of 2007. The main finding is that the projected default rates for all of 2007 are larger than those of 2005 and 2006 on average.

Asset Securitization and Bubbles: An Illustration of Subprime Mortgage Default Crisis

The paper intends to explore the cause and mechanism of subprime mortgage credit crisis occurrence in the United States and thereby the financial crisis resulted. The research indicates that, the outbreak of subprime crisis in the United States in 2007 is the result of multiple factors. Among them, the unreasonable securitization of assets, the excessive creation and over-financing of financial assets and the over-expansion of subprime mortgage credits, and the unceasing inflation and final burst of asset bubbles, are root causes. In addition, the relaxation of government regulation as well as the neglect of efficient guidance and control on real estate markets since 2002 has created a favorable external condition for the sustainable expansion of subprime mortgage credits and the rise of housing prices.

The Impact of Second Loans on Subprime Mortgage Defaults

An estimated 12.6% of primary mortgage loans were simultaneously originated with a second loan from 2004 until 2008, although relatively little is known about how the presence of such subordinate loans affects the default decisions of borrowers. We use a novel data series of loan servicing records from 2002 until 2010 to identify such borrowers and find evidence that the default behavior of these borrowers significantly differs from borrowers without second loans. Estimating a discrete‐time proportional odds hazard model, we find borrowers with a second loan were 62.7% more likely to default each month on their primary loan when conditioning alone on the attributes of the primary loan. However, borrowers of second loans were 58.3% less likely to default on their primary loan as compared to single‐loan borrowers with equivalent current combined attributes (i.e., loan‐to‐value, balance and interest rate). We hypothesize and provide empirical evidence that this occurs because borrowers with second loans have the option to sequentially default on each loan since subordinate lenders will not pursue foreclosure if borrowers have insufficient equity. Lenders of defaulted subordinate debt may revisit their decision to foreclose in the future after housing markets start to recover, thus prompting a new round of foreclosures.

Numerical ability predicts mortgage default.

Unprecedented levels of US subprime mortgage defaults precipitated a severe global financial crisis in late 2008, plunging much of the industrialized world into a deep recession. However, the fundamental reasons for why US mortgages defaulted at such spectacular rates remain largely unknown. This paper presents empirical evidence showing that the ability to perform basic mathematical calculations is negatively associated with the propensity to default on one's mortgage. We measure several aspects of financial literacy and cognitive ability in a survey of subprime mortgage borrowers who took out loans in 2006 and 2007, and match them to objective, detailed administrative data on mortgage characteristics and payment histories. The relationship between numerical ability and mortgage default is robust to controlling for a broad set of sociodemographic variables, and is not driven by other aspects of cognitive ability. We find no support for the hypothesis that numerical ability impacts mortgage outcomes through the choice of the mortgage contract. Rather, our results suggest that individuals with limited numerical ability default on their mortgage due to behavior unrelated to the initial choice of their mortgage.

Subprime Mortgage Defaults and Credit Default Swaps

This paper provides the first empirical investigation of the influence of credit default swaps (CDS) on the surge in subprime mortgage defaults, which is widely believed to be a driving force in the 2008/2009 financial crisis. In the years just before the 2008/2009 financial crisis, private mortgage securitizers were eager to supply world-wide demand for trillions of dollars of “highly-rated” mortgage-backed securities (MBS) created from pools of subprime mortgage loans. The net effect was that lenders offered more and more loans to higher-risk borrowers which inevitably drove much higher subprime mortgage defaults. We argue that this chain of events was in part fueled by the simultaneous increase in the market for credit default swaps. In particular, issuers and investors in MBS could hedge the credit risk of the subprime loans underlying these securities with CDS contracts. In this way, MBS market participants could limit their exposure to the risk of securitized loans, which in turn stimulated greater demand for riskier loans, which were eagerly supplied by mortgage loan originators who earned lucrative fees. This line of reasoning therefore suggests that CDS contracts insuring MBS backed by subprime loans had a direct effect on the surge in subprime mortgage defaults. We test this prediction using a large sample of privately securitized subprime mortgages that were originated during the period from 2003 to 2007. We find that CDS coverage increases the probability of subprime loan delinquency by 3.2% to 5.4%, or an additional $9.9 billion to $13.3 billion in delinquent loan value. The negative effect of CDS coverage on loan performance is similar across loan types, and is robust to correction for endogeneity of CDS coverage and to alternative definitions of concurrent CDS coverage. Taken together, we find strong evidence that CDS coverage had a significant effect on the subprime mortgage crisis.

Crisis, Response, and Innovation in Europe

The close economic ties between Europe and the United States and the crucial global monetary and financial role played by the City of London were the conduits for the lightning-fast spread of the crisis triggered by the sub-prime mortgage defaults in the U.S. and the consequent fall in global real aggregate demand in 2008. The effects of this crisis differed among euro area countries, among non-euro European Union countries, and among such neighboring nonmembers as Turkey and Russia. The differences appear to have been sharpest within the euro group.

Subprime Mortgage Defaults and Credit Default Swaps

Subprime Mortgage Defaults and Credit Default Swaps

The Impact of Second Loans on Subprime Mortgage Defaults

An estimated 12.6% of primary mortgage loans were simultaneously originated with a second loan from 2004 until 2008, although relatively little is known about how the presence of such subordinate loans affects the default decisions of borrowers. We use a novel data series of loan servicing records from 2002 until 2010 to identify such borrowers and find evidence that the default behavior of these borrowers significantly differs from borrowers without second loans. Estimating a discrete-time proportional odds hazard model, we find borrowers with a second loan were 62.7% more likely to default each month on their primary loan when conditioning alone on the attributes of the primary loan. However, borrowers of second loans were 58.3% less likely to default on their primary loan as compared to single loan borrowers with equivalent current combined attributes (i.e., loan-to-value, balance, and contract rate). We hypothesize this occurs because borrowers with second loans have the option to sequentially default on each loan since subordinate lenders will not pursue foreclosure if borrowers have insufficient equity. Lenders of defaulted subordinate debt may revisit their decision to foreclose in the future after housing markets start to recover, thus prompting a new round of foreclosures.

Did Bankruptcy Reform Cause Mortgage Default Rates to Rise?

This paper argues that the U.S. bankruptcy reform of 2005 played an important role in the mortgage crisis and the current recession. When debtors file for bankruptcy, credit card debt and other types of debt are discharged — thus loosening debtors' budget constraints. Homeowners in financial distress can therefore use bankruptcy to avoid losing their homes, since filing allows them to shift funds from paying other debts to paying their mortgages. But a major reform of U.S. bankruptcy law in 2005 raised the cost of filing and reduced the amount of debt that is discharged. The authors argue that an unintended consequence of the reform was to cause mortgage default rates to rise. Using a large dataset of individual mortgages, they estimate a hazard model to test whether the 2005 bankruptcy reform caused mortgage default rates to rise. Their major result is that prime and subprime mortgage default rates rose by 14 percent and 16 percent, respectively, after bankruptcy reform. The authors also use difference-in-difference to examine the effects of three provisions of bankruptcy reform that particularly harmed homeowners with high incomes and/or high assets and find that the default rates of affected homeowners rose even more. Overall, they calculate that bankruptcy reform caused the number of mortgage defaults to increase by around 200,000 per year even before the start of the financial crisis, suggesting that the reform increased the severity of the crisis when it came.

Did Bankruptcy Reform Cause Mortgage Defaults to Rise?

Homeowners in financial distress can use bankruptcy to avoid defaulting on their mortgages, since filing loosens their budget constraints. But the 2005 bankruptcy reform made bankruptcy less favorable to homeowners and therefore caused mortgage defaults to rise. We test this relationship and find that the reform caused prime and subprime mortgage default rates to rise by 23% and 14%, respectively. Default rates rose even more for homeowners who were particularly negatively affected by the reform. We calculate that bankruptcy reform caused mortgage default rates to rise by one percentage point even before the start of the financial crisis. (JEL D14, G01, G21, K35)

The Future of Corporate Governance: Network Governance – A Lesson from the Financial Crisis

10.2 trillion dollars have been lost in the US alone in the past two years. 45% of world’s wealth has been destroyed and three of the largest bankruptcies in the US have occurred in the past year. Just as the majority of observers thought lessons from Enron had been learned, crisis has struck again. Massive government intervention, the collapse of the banking system, and public outrage at the missteps of executives have again highlighted the weaknesses of mainstream corporate governance systems. Contrary to popular opinion the principal cause of the crisis was not sub-prime mortgage defaults but a failure of corporate governance, states the Association of Chartered Certified Accountants. While the OECD is brainstorming new corporate governance codes, public policy makers are calling for more comprehensive and tougher regulation. How likely will those changes help to prevent a future crisis? Not very likely, we argue, unless we fundamentally rethink the underlying failures inherent to the Anglo- Saxon structure of corporate governance and regulation. In the following article, we thus examine the systemic shortcomings of Anglo-Saxon corporate governance that arise from too much power being vested in a single board. We also lay out alternative governance models based on the natural science of communication and control. We then identify why a single board cannot adequately and reliably control the complex firms that wield influence over our lives. Examples of alternative models provide evidence that managers can design governance architectures that significantly reduce the risk of systematic blind spots, and the ensuing massive wealth destruction.

The anatomy of banking firm financial condition

This study employs factor analysis to develop a conceptual model of bank financial condition from financial ratios and other characteristics in Nigerian banking. It paints the anatomy of the phenomenon in a conceptual model around the prudential application of market power and market presence to transform deposit mobilisation, under a given macro-economic condition, into earnings quality with capital boosting confidence. The finding is relevant in the understanding of the 2008 global financial crisis. In the context of the global macro economy, the framework casts the current global financial meltdown in the light of the failure of market power and market presence to transform deposit mobilisation into earnings quality as imprudence stretched the sub-prime mortgage and credit default swap risks. Since capital could not offer cushion, confidence fell and bank financial condition grew worse.