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Tuesday, April 29th, 2008 Subscribe To Our Feed

Wikipedia says: The crisis began with the bursting of the US housing bubble[2][3] and high default rates on “subprime” and other adjustable rate mortgages (ARM) made to higher-risk borrowers with lower income or lesser credit history than “prime” borrowers. Defaults and foreclosure activity increased dramatically as ARM interest rates reset higher. The mortgage lenders that retained credit risk (the risk of payment default) were the first to be affected, as borrowers became unable or unwilling to make payments. Owing to a form of financial engineering called securitization, many mortgage lenders had passed the rights to the mortgage payments and related credit/default risk to third-party investors via mortgage-backed securities (MBS) and collateralized debt obligations (CDO). Corporate, individual and institutional investors holding MBS or CDO faced significant losses, as the value of the underlying mortgage assets declined. The widespread dispersion of credit risk and the unclear effect on financial institutions caused lenders to reduce lending activity or to make loans at higher interest rates. The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007,[10] with over 7.5 million first-lien subprime mortgages outstanding.[11]The estimated value of subprime adjustable-rate mortgages (ARM) resetting at higher interest rates is U.S. $400 billion for 2007 and $500 billion for 2008.

Refinance Mortgage Rates
Refinancing
• Credit risk: Traditionally, the risk of default (called credit risk) would be assumed by the bank originating the loan. Asset price risk: MBS and CDO asset valuation is complex and related “fair value” or “mark to market” accounting is subject to wide interpretation. Rising mortgage delinquency rates have reduced demand for such assets. Companies and structured investment vehicles (SIV) often obtain short-term loans by issuing commercial paper, pledging mortgage assets or CDO as collateral. Investors provide cash in exchange for the commercial paper, receiving money-market interest rates.
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• Bank corporations: The earnings reported by major banks are adversely affected by defaults on mortgages they issue and retain. Companies value their mortgage assets (receivables) based on estimates of collections from homeowners. Mortgage lenders and Real Estate Investment Trusts: These entities face similar risks to banks. Investors have become reluctant to fund such investments and are demanding higher interest rates. Special purpose entities (SPE): Like corporations, SPE are required to revalue their mortgage assets based on estimates of collection of mortgage payments.
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[edit] The housing downturn
Further information: United States housing market correction
Subprime borrowing was a major contributor to an increase in home ownership rates and the demand for housing. This demand helped fuel housing price increases and consumer spending. Between 1997 and 2006, American home prices increased by 124%.[28]Overbuilding during the boom period, increasing foreclosure rates and unwillingness of many homeowners to sell their homes at reduced market prices have significantly increased the supply of housing inventory available. As prices decline, more homeowners are at risk of default and foreclosure.
[edit] Role of borrowers
Mortgage fraud by borrowers from US Department of the Treasury [36]
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A variety of factors have caused lenders to offer an increasing array of higher-risk loans to higher-risk borrowers. [39][40] A study by the Federal Reserve indicated that the average difference in mortgage interest rates between subprime and prime mortgages (the “subprime markup” or “risk premium”) declined from 2.8 percentage points (280 basis points) in 2001, to 1.3 percentage points in 2007. In other words, the risk premium required by lenders to offer a subprime loan declined. In addition to considering higher-risk borrowers, lenders have offered increasingly high-risk loan options and incentives.
[edit] Role of mortgage brokers
Mortgage brokers don’t lend their own money.
Role of mortgage underwriters
See mortgage underwriting.
Then from 2001 to 2002, in the wake of the dot-com crash, the Federal Reserve Funds Rate was reduced from 6 percent to 1.24 percent, leading to similar cuts in the London Interbank Offered Rate that banks use to set some adjustable-rate mortgage (ARM) rates.
Role of credit rating agencies
Credit rating agencies are now under scrutiny for giving investment-grade ratings to securitization transactions (CDOs and MBSs) based on subprime mortgage loans.