1. BA 572 presents: The Subprime Mortgage Lending Market by Ofer Heyman May 11, 2011

2. Agenda (interruptions welcome) Understand it! – Mortgage and MBS context – What is subprime loan? – Criteria / Grading – History The 2007 Subprime Meltdown – Introduction – Personal perspective – By the numbers – Broader effects – Myths and Conclusion

3. Mortgages Risk free? / Poor investment?  Investor view point! Securities (g)

4. Subprime Loans - Basics What is it? – Lower than prime rate? Bad people? – Discretization (bb) Major Criteria for Grade A – FICO > 660 – PTI < 0.28 / 0.36 (bb) – LTV < 0.95 (bb)  Varies in practice – A-/B…/D

5. Subprime Loans - Basics

7. Size proportion (g)

8. Subprime Loans - History Milestones leading to the 2007 crisis – 1980: Allowing high rates (DIDMCA) – 1982: Permitting variable rates and balloons (AMTPA) – 1986: Tax Reform Act - prohibited other deductions – 1995: MBS with subprime-loan collateral more attractive – Late 1990s : rapid growth of highest risk Also, dropped rates  cash out – 2000-2005: rapid growth in volume, mainly lower risk – 2005-2006: The bubble grows – 2006-2007: Bubble bursts, increased rates  defaults – 2007-2008: MBS crash

9. The Subprime Crisis

13. The Crisis – broader effect

15. The Subprime Crisis Myths – Subprime went only to impaired borrowers – Subprime promoted home ownership – Decline in home value CAUSED the crisis – Subprime mortgages failed because of rate resets – Crisis was unexpected – Subprime market was too small to cause big troubles  – Complex system – Boom-Bust classic

16. Main Sources Videos – http://www.youtube.com/watch?v=HSjEyOp2dEM&feature=related – http://www.youtube.com/watch?v=q8hjUei-Nwo Papers and Web Sites – Ten Myths about Subprime Mortgages (May 9, 2009): http://www.clevelandfed.org/research/commentary/2009/0509.pdf – A Snapshot of Mortgage Conditions with an Emphasis on Subprime Mortgage Performance (August 27, 2008): http://www.federalreserveonline.org/pdf/mf_knowledge_snapshot- 082708.pdf – Wikipedia: http://en.wikipedia.org/wiki/Subprime_mortgage_crisis – The Evolution of the Subprime Mortgage Market (Feb 2006): http://research.stlouisfed.org/publications/review/06/01/ChomPen nCross.pdf