PrefBlog

This won’t be much of a review, but I have come across a rather provocatively abstracted paper: Understanding the Subprime Mortgage Crisis, by Yuliya Demyanyk and Otto van Hemert, both of the Federal Reserve Board, dated February 29, 2008:

[abstract] Using loan-level data, we analyze the quality of subprime mortgage loans by adjusting their performance for differences in borrower characteristics, loan characteristics, and house price appreciation since origination. We find that the quality of loans deteriorated for six consecutive years before the crisis and that securitizers were, to some extent, aware of it. We provide evidence that the rise and fall of the subprime mortgage market follows a classic lending boom-bust scenario, in which unsustainable growth leads to the collapse of the market. Problems could have been detected long before the crisis, but they were masked by high house price appreciation between 2003 and 2005.

[Extract from conclusion] The decline in loan quality has been monotonic, but not equally spread among different types of borrowers. Over time, high-LTV borrowers became increasingly risky (their adjusted performance worsened more) compared to low-LTV borrowers. Securitizers seem to have been aware of this particular pattern in the relative riskiness of borrowers: We show that over time mortgage rates became more sensitive to the LTV ratio of borrowers. In 2001, for example, the premium paid by a high LTV borrower was close to zero. In contrast, in 2006 a borrower with a one standard deviation above-average LTV ratio paid a 30 basis point premium compared to an average LTV borrower.

…

In many respects, the subprime market experienced a classic lending boom bust scenario with rapid market growth, loosening underwriting standards, deteriorating loan performance, and decreasing risk premiums. Argentina in 1980, Chile in 1982, Sweden, Norway, and Finland in 1992, Mexico in 1994, Thailand, Indonesia, and Korea in 1997 all experienced the culmination of a boom-bust scenario, albeit in different economic settings.

Were problems in the subprime mortgage market apparent before the actual crisis showed signs in 2007? Our answer is yes, at least by the end of 2005. Using the data available only at the end of 2005, we show that the monotonic degradation of the subprime market was already apparent. Loan quality had been worsening for five consecutive years at that point. Rapid appreciation in housing prices masked the deterioration in the subprime mortgage market and thus the true riskiness of subprime mortgage loans. When housing prices stopped climbing, the risk in the market became apparent.

 

This entry was posted on Tuesday, March 11th, 2008 at 7:56 pm and is filed under Interesting External Papers, Sub-Prime!. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.