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Managing Mortgage Credit Risk: What Went Wrong With the Subprime and Alt-A Markets?

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  • Man Cho

    ()
    (The KDI School of Public Policy and Management)

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    Abstract

    The purpose of this study is two-fold: first, to explain the demise of subprime and Alt-A mortgage markets in the U.S. from the viewpoint of measuring and managing mortgage credit risk; and secondly, to discuss several policy lessons that can be learned from the market meltdown. To that end, three tiers of mortgage credit models are elaborated, including the scoring (or risk rank-ordering), risk-based pricing, and ¡§sizing¡¨ (or the analytics used in determining subordination levels of credit-sensitive mortgage backed security (MBS) deals) models. Using these as conceptual underpinning, empirical evidence is surveyed to document key contributing factors to the market demise. Those that are identified include the non-availability of reliable mortgage performance data, lack of theory as well as industry best-practices in performing simulation-based mortgage risk assessments, complex and arcane structures of mortgage backed securities, and information asymmetry among the parties involved in the security transactions. The overall conclusion derived is that the participants to these market segments surpass their risk management capabilities in globalizing funding for subprime and Alt-A mortgages. The policy lessons emphasized are the importance of the infrastructure of proper risk assessment and risk-based pricing, as well as prudent and transparent MBS products along with periodic information disclosure.

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    Bibliographic Info

    Article provided by Asian Real Estate Society in its journal International Real Estate Review.

    Volume (Year): 12 (2009)
    Issue (Month): 3 ()
    Pages: 295-324

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    Handle: RePEc:ire:issued:v:12:n:03:2009:p:295-324

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    Postal: Asia Real Estate Society, 51 Monroe Street, Plaza E-6, Rockville, MD 20850, USA
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    Web page: http://www.asres.org/

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    Postal: Asian Real Estate Society, 51 Monroe Street, Plaza E-6, Rockville, MD 20850, USA
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    Related research

    Keywords: Subprime mortgage; Mortgage-backed securities; Mortgage default; Credit risk management;

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    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 56(3), pages 291-299, September.
    2. Coleman IV, Major & LaCour-Little, Michael & Vandell, Kerry D., 2008. "Subprime lending and the housing bubble: Tail wags dog?," Journal of Housing Economics, Elsevier, Elsevier, vol. 17(4), pages 272-290, December.
    3. Man Cho, 2007. "180 Years’ Evolution of the US Mortgage Banking System: Lessons for Emerging Mortgage Markets," International Real Estate Review, Asian Real Estate Society, Asian Real Estate Society, vol. 10(1), pages 171-212.
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    6. Anthony Pennington-Cross & Giang Ho, 2006. "The termination of subprime hybrid and fixed rate mortgages," Working Papers 2006-042, Federal Reserve Bank of St. Louis.
    7. Wayne Passmore, 2005. "The GSE implicit subsidy and the value of government ambiguity," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2005-05, Board of Governors of the Federal Reserve System (U.S.).
    8. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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    11. Calhoun, Charles A & Deng, Yongheng, 2002. "A Dynamic Analysis of Fixed- and Adjustable-Rate Mortgage Terminations," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 24(1-2), pages 9-33, Jan.-Marc.
    12. Brent W. Ambrose & Michael LaCour-Little & Zsuzsa R. Huszar, 2005. "A Note on Hybrid Mortgages," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 33(4), pages 765-782, December.
    13. S. Baranzoni & P. Bianchi & L. Lambertini, 2000. "Market Structure," Working Papers 368, Dipartimento Scienze Economiche, Universita' di Bologna.
    14. Mark Swinburne & Stéphanie Marie Stolz & Marina Moretti, 2008. "Stress Testing At the IMF," IMF Working Papers 08/206, International Monetary Fund.
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