Subprime Mortgage Market Research Articles

Diversification and Screening

I study two-way effects between financial markets and contractual agreements with a risk sharing component, such as compensation packages within a firm, or mortgages and loans. I construct a model with many Units, in each of which one of the contracting individuals, the Agent, has private information, while the uninformed individual, the Principal, has the opportunity to trade with the Principals in other Units. I give general conditions under which financial markets induce a transfer of risk from Agents to Principals. I also show how asymmetric information interacts with financial markets through two channels. First, the distortion of the allocation of the high risk Agents, feeds back in the market portfolio increasing risk on markets, and in the contracts of the low risk Agents. Secondly, markets change the Principals' screening problem preventing low risk Agents from enjoying an information rent. The model results can explain empirical evidence from the subprime mortgage market during the securitization boom leading to the 2008 financial crisis and suggest further implications for other markets segment.

The Analysis of the Collapse of Lehman Brothers

The causes of the failure of Lehman Brothers, preventive measures, and recommendations for going forward constitute the subject for discussion in this paper. The bankruptcy of Lehman Brothers in 2008 sent shock waves through the entire global banking and financial system across numerous and unexpected transmission channels when the price bubble in the US housing market tied to the subprime mortgage market suddenly burst. Actions, which largely relate to the risk return relationship, bad accounting treatment of financial transactions, and loose risk management policies and strategies at Lehman, led the financial conglomerate to its eventual collapse. Global stock markets, individual and corporate investors, and staff of the Firm and its other related businesses bore the brunt of the financial disaster in the form of huge losses, liquidations, job losses, reduction in asset prices and a subsequent global financial crises which could have been prevented. Strong corporate governance structures, robust risk management policies, and constant, effective monitoring and supervision of financial institutions, especially the larger ones by regulatory bodies are therefore highly recommended to ensure against failure of financial institutions.

Performance of Commercai Banks of Pakistan in the backdrop of Global Financial Crisis

This research paper highlights the efficiency & performance of commercial banks of Pakistan after the emergence of global financial crisis. The crisis were basically started in United States after the collapse of subprime mortgage market but engulfed the entire globe though the level of severity was different from country to country. Paper also discusses the challenges and obstacles hindered the smooth performance of banking sector in Pakistan. Five big banks of the country were selected to evaluate their efficiency in terms of profits, liquidity and solvency.For this purpose various financial ratios were used to avoid size disparity of banks. The banks play an important role of financial intermediation; channelize savings of public to investors hence basic key performance indicators for this research were deposits, profit, advances and capital.An attempt has been made to examine the growth and sustainability of banks through their performance from 2007 to 2012, before and after crisis.The main findings are (I) the profitability was affected adversely (II) Non Performing Loans were increasedsignificantly after tight control and management for several years.(III) It was explored that costly deposits were mobilized to maintain the book size and restore the confidence of depositors and all stake holders. (IV)The stability of the system remained unquestionable due to maintenance of Capital Adequacy Ratio well above the targeted ratio of 8 % in terms of Basel accord.

The Federal Reserve's Financial Crisis Response A: Lending & Credit Programs for Depository Institutions

Beginning in the summer 2007 the Federal Reserve (the Fed) was called upon to address a severe disruption in the interbank lending markets sparked by a downturn in the subprime mortgage market. As these developments began to impact the ability of banks to raise adequate funding, the Fed encouraged them to utilize the Discount Window (DW), its standing facility for lending to depository institutions, and repeatedly decreased the lending rate to make the facility more accessible. Despite the Fed’s efforts, for a number of reasons, including historical perceptions of stigma, banks were reluctant to utilize the DW. In December 2007, the Federal Reserve introduced the Term Auction Facility (TAF), which provided term loans via auction utilizing the same collateral that could have been used at the DW. The TAF was immediately and aggressively utilized and would become one of the largest facilities employed by the Fed to combat the financial crisis. Ultimately, the Fed lent a total of $3.8 trillion to 416 banks under the TAF. This case examines the Fed’s use of the DW and the TAF to provide liquidity to depository institutions in fighting the financial crisis.

Financial innovation as a potential force for a positive social change: The challenging future of social impact bonds

Since the last financial crisis, financial innovation has been called into question because it generated complex financial assets detached from economic reality. More precisely, the development of very abstract contracts ballooning subprime mortgage market would be at the origin of the last crisis. Financial creativity can produce severe consequences but it can also drive socio-economic changes favourable to the society. This article presents social impact bonds as a telling example of a financial innovation that could contribute to a significant improvement of society. These assets are used to fund social programs such as helping homeless people, rehabilitating prisoners or supporting early interventions with underprivileged people. By redesigning social programs through market-based solutions, SIBs enhanced transparency of expenditures made by government, they can help to stabilize economic activity and they can contribute to the self-realization of disadvantaged people. This reflexive paper reconsiders finance through the lens of the financial and ethical implications of these new assets. By combining usual aspects of finance with social welfare, social impact bonds imply new practices but also a new way of thinking the concept of return. This article aims at discussing these aspects.

Liquidity Provision, Credit Risk and the Bond Spread: New Evidence from the Subprime Mortgage Market

We study the determinants of the subprime mortgage loan spread, with a particular focus on funding liquidity and default-liquidity interaction effects. We find that sector-level as well as macro funding liquidity provision affected subprime loan rates, explaining a significant portion of the variation in spreads. Liquidity conditions just prior to loan default mattered, indicating destabilizing liquidity-driven default effects. A reduction in macro funding liquidity provision at the time of loan origination predicts worsening credit performance, implying a stabilizing default-driven liquidity component in the loan spread. Positive default-liquidity feedback (spiraling) effects are also documented.

The Road Towards the Establishment of the European Banking Union

The rising delinquencies in the U.S. subprime mortgage market in 2006 and the succeeding collapse in housing prices had a considerably negative impact on the functioning of the European financial systems and the smooth operation of European economies. Indeed, in the Euro-area, what started as a financial crisis escalated to a twin crisis after being doubled by the eruption of a massive sovereign debt crisis in 2010. The lack of an established set of bank supervision and resolution strategies at the Euro-area level, the vicious circle between banks and European nation-states, the threats for the sustainability of the common currency, and the deterioration of the market conditions were the key factors which lately led to the acceleration of the steps towards the creation of a banking union in Europe. The principal aim of the European Banking Union is to shape the necessary legal and institutional framework and provide the authorities with powers and tools to deal with ailing banks in order to prevent the devastating effects that a future shock may have on the financial system, the real economy, and the society. This paper presents the formal reactions of the sovereigns and the European Central Bank to the twin crisis, and critically discusses the key problems and the inherent weaknesses which led to the establishment of a banking union for the Euro-area member states. The structure of the banking union, the various aspects of its operation, and its future prospects are also presented and discussed.

Subprime Mortgages and Housing Price Variations in the Philadelphia Metropolitan Area

Over the past decade, both the housing market and the subprime mortgage market in the United States experienced a rise and fall. To explore whether subprime lending has increased or decreased social inequality between subprime neighborhoods and nonsubprime neighborhoods, this article examines the relationship between subprime mortgages and housing price variations within the Philadelphia Metropolitan Statistical Area (MSA), using a global, ordinary least squares (OLS) method and a local, geographically weighted regression (GWR) method. The results show that neighborhoods obtaining disproportionate numbers of subprime mortgages enjoyed lower housing price appreciation rates than other neighborhoods during the housing boom era but suffered higher housing price depreciation rates during the housing bust era, after controlling for other variables. The results also show that the association between housing price variations and explanatory variables differs across geographic submarkets. The empirical evidence draws some policy implications, such as rethinking the homeownership policy through expanding subprime lending, as well as promoting place-based housing policymaking. Combining OLS and GWR, this article improves the understanding of how subprime lending exacerbated social inequality at the neighborhood level.

Dynamic Co-movements between Economic Policy Uncertainty and Housing Market Returns

Executive SummaryThe financial crisis that followed the meltdown of the U.S. subprime mortgage market and the subsequent Great Recession were characterized by exceptionally large falls in house prices, as well as unprecedented levels of economic uncertainty. Against this background, we examine dynamic correlations between housing market returns and the economic policy uncertainty (EPU) index developed by Baker, Bloom, and Davis (2012), controlling for economic and financial fundamentals. We find negative correlations throughout the 1987–2014 period. More importantly, correlations are time-varying and tend to increase sharply in times of high economic uncertainty, notably around U.S. recessions. This implies that tail risks, or the probability of unusually large losses for investors in real estate and related securities following spikes in uncertainty, are significant.

Single-Family Housing May Have Been a False Culprit

The dominant account of the Great Recession in the United States’ economy links the economic decline to the preceding boom in the sector of single-family housing and related financial markets. Even the existing explanations of the crisis in terms of the Austrian Business Cycle Theory (ABCT) have focused on this part of the U.S. economy. In this paper, we will argue that 1-4-family housing construction projects do not seem to be the right phenomenon to focus on, especially for the purposes of ABCT. Instead, we provide evidence that long-term private construction projects are prima facie a better candidate for at least a partial explanation of the boom and bust of the 2000s. We also propose a potential connection between the failure of long-term construction projects and the crisis in the subprime mortgage market.

Political Economy and Housing in the Twenty-first Century – From Mobile Homes to Liquid Housing?

The recent Global Financial Crisis started as a crisis in the US sub-prime mortgage market, and rapidly spread to a wider financial crisis. This article suggests that beyond the crisis, we can now see that households are playing an evolving role as a site of risk absorption. In so doing, households have become a frontier of capital accumulation, not just as producers and consumers, but also as financial traders. Households are increasingly buying financialized products as an ordinary part of daily subsistence – houses, insurance, education, electricity and mobile phones. But at a level beyond the household’s daily reality, these regular purchases are being re-specified as assets, on which asset backed securities are built and then traded. It is in this way that by securitizing mortgage debt, finance has given global liquidity to housing. The size of securitized markets on housing as well as household assets and payment streams now dwarfs stock markets. The requirements of this emergent financial citizenship for the house and households extend beyond just honouring payments on a home purchase, it is requiring a culture of financial calculation that becomes absorbed as part of the daily norms and dispositions of social being. The presumption of rights of access to housing, education and health care are being replaced by the acceptance of individual financial participation and calculation. Here, we argue housing is being reconstructed as both the capital base for, and site of, individualized life course risk management.

Regulations, Community Bank and Credit Union Exits, and Access to Mortgage Credit

We analyze the effect of a U.S. subprime mortgage regulation on the availability of mortgage credit. Due to all subprime mortgage originators being affected by the regulation, there is no natural control group. We use the assumption of profit maximization to construct a control group. We find no statistically or economically significant impact, despite about 200 institutions exiting the subprime mortgage market in over 200 counties. These results, along with other evidence presented in the paper, strongly suggest that consumers were able to switch to similar loans originated by the exiting creditors' competitors. We then perform several robustness checks, including comparing our approach with a more traditional method of using an unaffected but related market (subprime manufactured housing) as a control group and analyzing the effects of a later regulation exempting many creditors from the aforementioned regulation, with this newer regulation presenting a natural threshold for a regression discontinuity approach.

Avoiding the Next Global Financial Crisis: A Canadian Perspective, Focusing on the 'Boundedly Rational Consumer'

The collapse of the American subprime mortgage market and the global financial crisis and recession essentially came to an end in 2009 and yet these events continue to haunt the global economy. They raise difficult to answer challenges and questions regarding whether enough has been done to prevent another global financial crisis in the near to medium term future, to compensate for the substantial harm incurred by consumers, smaller businesses and other market participants, and to re-instill confidence in the global financial regulatory system. The major argument of this paper is that changes in national and global financial sector markets and regulatory regimes since the collapse of the American subprime mortgage market and global financial crisis provide the boundedly rational but willing to learn financial consumer with somewhat better protection. However, these changes by themselves are not sufficient to prevent another regulatory debacle that would cause as much or even more harm to the financial consumer in the future – including in countries like Canada and Australia that were less affected by the last calamity. The monetary and psychic payoffs from gaming the financial regulatory system are still too attractive, and the culture of high risk, reckless, irresponsible, myopic, and pushing the envelope conduct is too entrenched, to respond to traditional top-down laws, regulations and enforcement practices of governments and their financial regulatory authorities. Moreover, the further globalization of financial markets; the growing complexity of financial products, transactions and contracts; and the integration of emerging market economies into global financial markets; pose new and unfamiliar dangers to national and international financial markets and financial consumers. These trends suggest that countries like Canada and Australia that were less influenced by the 2007 crisis may be less fortunate in the future. The paper’s major conclusion is that the likelihood of another financial crisis of similar magnitude can be diminished if there is concerted systematic action under a sustainable governance mode which involves inter-governmental and governmental bodies, the private sector, civil society, and individual consumers. Each actor has unique capabilities and energies. In some respects, the polycentric and distributed governance approach proposed here involves enhanced collaboration among all actors. In others, it involves recognition of the need for enhanced mechanisms to provide “checks and balances” on the powers and capabilities of any one actor or instrument. Harnessing the insights, capabilities and energies of all actors, including those of the financial consumer, will better ensure that: (i) the corporate culture of gaming the regulatory system will be reduced, (ii) the global contagion that characterized the last financial crisis will be mitigated and stopped at more national borders, and (iii) over time the current too big to fail approach to large international banks and other financial service providers will be recognized as unnecessary and a false hypothesis. This approach is referred to in this paper as “sustainable governance” because of our conclusion that both top-down and more organic bottom-up approaches will be needed, given the complexity and magnitude of the governance task. We recommend that more research should be focused on the self-actualization governance capabilities of individual consumers to protect themselves, and on the ability of civil society organizations to provide independent research, consumer information, “checks and balances” oversight functions, and strong advocacy on behalf of consumers. These two aspects appear to be under-studied in the financial reform research and literature conducted to date.

BANK DIVIDENDS, REAL GDP GROWTH AND DEFAULT RISK

ABSTRACTWe reveal evidence that the US aggregate bank dividends exercise a causal impact on the US real GDP growth during the period from the introduction of the Prompt Corrective Action framework in 1992 until the outburst of the subprime mortgage market crisis in 2007. Over this period, the positive signalling effects of bank dividends outperform the negative effect of dividends on default risk. During the pre‐Prompt Corrective Action and the recent post‐2007 periods, bank dividends do not affect GDP growth. This regime‐dependent relation is due to an asymmetric role of bank default risk. These findings are of interest to bank regulators in reassessing the role of bank dividends within Basel III and carry important policy implications as bank dividends constitute an important tool available to policy makers for strengthening real activity. Copyright © 2014 John Wiley & Sons, Ltd.

Analysis of spatial autocorrelation in higher-priced mortgages: Evidence from Philadelphia and Chicago

An accurate and reliable model is critical for analyzing racial/ethnic and socioeconomic inequality in the spatial distribution of higher-priced/subprime mortgages. Employing a spatial error model, this research analyzes spatial autocorrelation in higher-priced mortgages in the Philadelphia and Chicago MSAs. The empirical results show that higher-priced mortgages occur disproportionately on tracts with a higher proportion of African–American and Hispanic residents, lower income, and higher investment risks, as well as tracts in fringe suburbs. The results imply that the government needs to enforce fair lending policies to alleviate social inequality arising from subprime lending. The paper also demonstrates the difference of subprime mortgage market dynamics between two MSAs, suggesting that local governments need to consider local demographic and socioeconomic characteristics when they design housing policy interventions. Furthermore, the paper compares the results of the OLS model and the spatial error model, highlighting that the spatial error model can yield better model fitness and more accurate estimate coefficients. Analyzing spatial autocorrelation is a methodological innovation in mortgage studies, which can advance our understanding of the spatial distribution of higher-priced mortgages across neighborhoods within a MSA.

Sucker punched by the invisible hand: the world financial markets and the globalization of the US mortgage crisis

The worldwide financial crisis that began in 2007 was set off by the collapse of the subprime mortgage market in the USA. The crisis simultaneously reverberated to banks around the world, and event ...

A Study on the Implications of Basel-III on Indian Banking Industry

The global financial meltdown aftermath in banking sector 2007–2009 was triggered by flaws in the U.S sub-prime mortgage market. Several banks found it difficult to maintain adequate liquidity and central bank has to pump in liquidity. In this context, Basel III accord was released in 2010 which identified the loopholes of Basel–II accord on the banks debt regulation. Basel III attempts to increase the resilience on internationally active banks to liquidity stresses. Basel III protocol embarked and notified for Indian banks by RBI, is a comprehensive set of reforms measures to strengthen the regulations, supervision and risk management of the banking sector. The objective is to improve the banking sector ability to absorb shocks arising from financial and economic stress. Basel-III guidelines were imposed for more rigorous and stringent Capital and Liquidity requirements and prescribe changes for the way deductions are made while calculating the capital adequacy percentages which has an impact on Indian banks, which do not have re-securitization exposures and small trading books. The present research paper attempts to examine the Basel-III compliance, analyze implications on Indian banks and suggest actions for future directions of regulations. Implementation of Basel-III effective from April 01, 2013 in a phased manner and will be fully implemented as on March 31, 2019. Burgeoning issues to be resolved and banks cannot afford to be idle, So Basel III measures ensures that banking system as a whole does not crumble and its spill over impact on the real economy is minimized.

Changes in monetary policy after the crisis - towards preventing banking sector instability

The instability of the banking sector has become the subject of wider scientific research during the global financial crisis. The financial crisis of the first decade of the twenty-first century began in the U.S. subprime mortgage market and quickly spread to the whole banking sector in the United States as well as in many countries of the global economy. Among five major American investment banks - Lehman Brothers went bankrupt, Bear Stearns and Merrill Lynch were taken over by other banks, and Goldman Sachs and Morgan Stanley were transformed into commercial banks, which were covered by the supervision and regulations of the central bank - the Federal Reserve System. The consequences of the global financial crisis also affected British banks, including The Royal Bank of Scotland, Lloyds Bank, Halifax, Abbey Bank, Barclays Bank and NBC Bank. In Iceland, during the global financial crisis which affected the Icelandic banking sector, three largest banks: Glitnir Bank, Landsbanki and Kauphting were nationalized, which means that the control was taken over by their government. It has caused, that reflections and scientific research on financial stability were replaced by the study of instability in particular in relation to the banking sector. The main aim of the study is to identify the general framework of the response system of central banks on the phenomenon of banking sector instability, in the context of preventing it in a long term. Current - the traditional system proved to be ineffective, because it did not prevent the spread of the factors that led to the destabilization of the banking market

Collateral equilibrium, I: a basic framework

Much of the lending in modern economies is secured by some form of collateral: residential and commercial mortgages and corporate bonds are familiar examples. This paper builds an extension of general equilibrium theory that incorporates durable goods, collateralized securities, and the possibility of default to argue that the reliance on collateral to secure loans and the particular collateral requirements chosen by the social planner or by the market have a profound impact on prices, allocations, market structure, and the efficiency of market outcomes. These findings provide insights into housing and mortgage markets, including the subprime mortgage market.

Stages of the Ongoing Global Financial Crisis: Is There a Wandering Asset-Price Bubble?

This study identifies five distinctive stages of the current global financial crisis: the meltdown of the subprime mortgage market, spillovers into broader credit market, the liquidity crisis epitomized by the fallout of Northern Rock, Bear Stearns with contagion effects on other financial institutions, the commodity price bubble, and the ultimate demise of investment banking in the U.S. Monetary policy responses aimed at stabilizing financial markets are proposed. The study argues that the severity of the crisis is influenced strongly by changeable allocations of global savings, which lead to over-pricing of varied types of assets. The study calls such process a “wandering asset-price bubble”. Unstable allocations have elevated market, credit and liquidity risks. Since its original outbreak induced by the demise of the subprime mortgage market and the mortgage-backed securities in the U.S., the crisis has reverberated across other credit areas, structured financial products and global financial institutions.