Many analysts believe that problems in the U.S. housing market initiated the 2008–2010 global
financial crisis. In this regard, the subprime mortgage crisis (SMC) shook the foundations of the
financial industry by causing the failure of many iconic Wall Street investment banks and prominent
depository institutions. This crisis stymied credit extension to households and businesses
thus creating credit crunches and, ultimately, a global recession. This thesis specifically discusses
the SMC and its components, causes, consequences and cures in relation to subprime mortgages,
securitization, as well as data. In particular, the SMC has highlighted the fact that risk, credit ratings,
profit and valuation as well as capital regulation are important banking considerations. With
regard to risk, the thesis discusses credit (including counterparty), market (including interest rate,
basis, prepayment, liquidity and price), tranching (including maturity mismatch and synthetic),
operational (including house appraisal, valuation and compensation) and systemic (including maturity
transformation) risks. The thesis introduces the IDIOM hypothesis that postulates that the
SMC was largely caused by the intricacy and design of subprime agents, mortgage origination and
securitization that led to information problems (loss, asymmetry and contagion), valuation opaqueness
and ineffective risk mitigation. It also contains appropriate examples, discussions, timelines
as well as appendices about the main results on the aforementioned topics. Numerous references
point to the material not covered in the thesis, and indicate some avenues for further research.
In the thesis, the primary subprime agents that we consider are house appraisers (HAs), mortgage
brokers (MBs), mortgagors (MRs), servicers (SRs), SOR mortgage insurers (SOMIs), trustees,
underwriters, credit rating agencies (CRAs), credit enhancement providers (CEPs) and monoline
insurers (MLIs). Furthermore, the banks that we study are subprime interbank lenders (SILs),
subprime originators (SORs), subprime dealer banks (SDBs) and their special purpose vehicles
(SPVs) such as Wall Street investment banks and their special structures as well as subprime investing
banks (SIBs). The main components of the SMC are MRs, the housing market, SDBs/hedge
funds/money market funds/SIBs, the economy as well as the government (G) and central banks.
Here, G either plays a regulatory or policymaking role. Most of the aforementioned agents and
banks are assumed to be risk neutral with SOR being the exception since it can be risk (and regret)
averse on occasion. The main aspects of the SMC - subprime mortgages, securitization, as well as
data - that we cover in this thesis and the chapters in which they are found are outlined below.
In Chapter 2, we discuss the dynamics of subprime SORs' risk and profit as well as their valuation
under mortgage origination. In particular, we model subprime mortgages that are able to fully
amortize, voluntarily prepay or default and construct a discrete–time model for SOR risk and profit
incorporating costs of funds and mortgage insurance as well as mortgage losses. In addition, we
show how high loan–to–value ratios due to declining housing prices curtailed the refinancing of
subprime mortgages, while low ratios imply favorable house equity for subprime MRs.
Chapter 3 investigates the securitization of subprime mortgages into structured mortgage products
such as subprime residential mortgage–backed securities (RMBSs) and collateralized debt obligations
(CDOs). In this regard, our discussions focus on information, risk and valuation as well as
the role of capital under RMBSs and RMBS CDOs. Our research supports the view that incentives
to monitor mortgages has been all but removed when changing from a traditional mortgage model to a subprime mortgage model. In the latter context, we provide formulas for IB's profit
and valuation under RMBSs and RMBS CDOs. This is illustrated via several examples. Chapter 3
also explores the relationship between mortgage securitization and capital under Basel regulation
and the SMC. This involves studying bank credit and capital under the Basel II paradigm where
risk–weights vary. Further issues dealt with are the quantity and pricing of RMBSs, RMBS CDOs
as well as capital under Basel regulation. Furthermore, we investigate subprime RMBSs and their
rates with slack and holding constraints. Also, we examine the effect of SMC–induced credit rating
shocks in future periods on subprime RMBSs and RMBS payout rates. A key problem is whether
Basel capital regulation exacerbated the SMC. Very importantly, the thesis answers this question
in the affirmative.
Chapter 4 explores issues related to subprime data. In particular, we present mortgage and securitization
level data and forge connections with the results presented in Chapters 2 and 3.
The work presented in this thesis is based on 2 peer–reviewed chapters in books (see [99] and [104]),
2 peer–reviewed international journal articles (see [48] and [101]), and 2 peer–reviewed conference
proceeding papers (see [102] and [103]). / Thesis (Ph.D. (Applied Mathematics))--North-West University, Potchefstroom Campus, 2011.
| Identifer | oai:union.ndltd.org:netd.ac.za/oai:union.ndltd.org:nwu/oai:dspace.nwu.ac.za:10394/4591 |
| Date | January 2010 |
| Creators | Thomas, Soby |
| Publisher | North-West University |
| Source Sets | South African National ETD Portal |
| Detected Language | English |
| Type | Thesis |
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