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Market Complacency

1. Low interest rates in the early 2000s led to a housing boom and steadily increasing home prices, fueling market complacency. Homebuyers expected prices to keep rising at unsustainable rates of over 10% annually. 2. Loosened lending standards, including interest-only loans and low-documentation loans, combined with securitization of subprime mortgages, exacerbated the risks of default. Mortgage bonds were given high credit ratings without considering risks of a housing downturn. 3. Rating agencies had conflicts of interest as large banks purchasing many ratings could influence how ratings were determined. Banks optimized tools to achieve highest ratings rather than ensure adequate risk assessment. This inflated perceptions of risk, masking the risks

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Irfan Anwar
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44 views

Market Complacency

1. Low interest rates in the early 2000s led to a housing boom and steadily increasing home prices, fueling market complacency. Homebuyers expected prices to keep rising at unsustainable rates of over 10% annually. 2. Loosened lending standards, including interest-only loans and low-documentation loans, combined with securitization of subprime mortgages, exacerbated the risks of default. Mortgage bonds were given high credit ratings without considering risks of a housing downturn. 3. Rating agencies had conflicts of interest as large banks purchasing many ratings could influence how ratings were determined. Banks optimized tools to achieve highest ratings rather than ensure adequate risk assessment. This inflated perceptions of risk, masking the risks

Uploaded by

Irfan Anwar
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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1. Market Complacency Seeds from the current disaster were sewn through the housing boom.

A long period of low interest rates lead to higher real estate prices, which was quite unusual historical standards. Since March 1997 - June 2006, Case Sheller national price index and housing were being increased each month, instead of two. In the same tenure the normal property price growth of 12.4% per year. This rise was partially driven by interest rates extremely low. In the period from January 2002 - January 2004, the normal three month T-Bill of 1.3 percent, So far the average in the last forty years has been 6.1%. This continuous increase in prices will bring glamour and desire of many owners of real prices will always occur. In the 2005 survey of home buyers in San Francisco and the Schiller noted that the average increase is expected in the next ten years is 14% annually, while the average of 9 percent per year (Sheller, 2008). the level of property crime has decreased significantly. The reason was not only a relatively favourable economic conditions, but continued growth in property prices. First, homeowners fought to be able to pay their mortgage, when it increases the equity in the home Second, the availability of innovative mortgage options as negative amortization and interest, which allows buyers to purchase homes they could not maintain their mortgage payments in equilibrium, depends on the ability to refinance their prices steadily high. the share of interest only calculator is increased from zero to 38 percent. the percentage of low-documentation loans increased from 29 percent to 51 percent, and debt 39.6 42.4 to income. This relaxation is aggravated by the securitization, the practice of combining mortgages and sells them in the package. For the first time such a practice, which was used for decades for conventional loans, with positive results for both interest rates on mortgages and property, is conducted to reduce the quality of mortgage loans. Knowing that it will be the ultimate risk of default, many creators of standards for mortgage loans weakened further. As Keys et al. (2008) show that guarantees a higher probability of default of securities at a rate higher than 20 percent for the comparable results of FIG. The quality of these loans must be monitored in the capital market that bought them, but many of the difficulties in measuring less than perfect. In the first place, the combined sales of mortgages in areas that had a different experience. Using the history given peak were considered absolutely safe, but historical records do not take into account the possibility of a significant decline in the price of real estate in the country, as we have had since the Great Depression and every time it is used many times to a maximum return on time. They do not include these models the effect of changes in credit standards for the probability of default. As Rajan et al. (2008) model shows the default low securitization period breaks down in the high securitization regime of "systematic" and "predict": By default, understates especially in countries with low FICO scores. Finally, these models do not reflect the ratio of default and the damage and the rest of the economy. According to Darrell Duffie, one of the fathers of these mental models "of banks, insurance companies and other financial institutions managing portfolios of credit risk need an integrated model that reflects the correlation defaults, and changes in the external market. However, such a model," Duffie (2004).

Second, many problems have limited the number of players (including Lehman was one) has changed the fundamental nature of the relationship between rating agencies and investment banks that issue these securities. In a sample of 1257 securitization of mortgage loans and Nadauld Sherlund (2008) found that Lehman was only 128 transactions. In the past, each client, offers only a few names, there is no market power of credit rating agencies. With the issuance of bonds secured by the funds, large investment banks bought hundredth assessment services on an annual basis. So, instead of submitting the application to meet the rating agencies, investment banks to buy the best kinds of books, and even how to create a dangerous safety assessment of a AAA. For example, Standard & Poor's website is used to assess the CDO handbook (Benmelech and Dlugoszb, 2008). The assessor is to optimize the tool, which allows issuers of CDOs to achieve the highest possible credit rating, the lowest price. The result of this evaluation was to provide the issuer with a measure of "high security", according to S & P "means the percentage of assets should be conditionally deleted (our) transactions in order to ensure that adequate (eg Republic of China is 100%) supports a certain level of rating.(Benmelech and Dlugoszb, 2008). The market is not completely wrong this procedure: AAA asset-backed securities had a higher yield than corporate AAA, a clear indicator of increased risk. Benmelech and Dlugoszb (2008), for example, say that on average their example spreads to LIBOR AAA tranches in our sample is 32 basis points.

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