The issues with subprime mortgages outline

Predatory Lending and the Subprime Mortgage Crisis

The issues with subprime mortgages are recognized by now, with many evasions and consequences for businesses and financiers in a similar way. A lot of writers have been swift to charge what they call hungry, predatory lenders who oppressed poor, simple and uneducated borrowers. This is expected for the reason that lenders have been blamed of many comparable sins in earlier periods. For instance, the uproar following the printing of Apgar et al. (2006)

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, which has been extensively deduces as proof of racial bigotry, is renowned. So far other explanations of the data exist, with Elliehausen & Staten (2004) being a well-known case in point.

Analysts state that minorities disburse bigger overages or yield spreads than Caucasians, nevertheless point the result to dissimilarities in the groups of borrowers more willingly than to racial bias. Arthur (2008) and others dispute that racial discrimination is unsuccessful and that rising opposition is the favored move toward getting rid of discrimination. The tip is that the fundamental economic cause for any inequality is significant if watchdogs and lawmakers are to devise and pass suitable policy to iron out any suspected problem. Although the Hungry, Predatory Lender tale for subprime problems makes for good reading and headlines and even better scapegoats, it is not matching with the statistics. At the very least, there must be much more to the story.

II) Nature of the Problem: Mortgages and Laws

Carrying debt on a house is not necessarily a problem, provided you can manage to pay it. If the only sensible way to purchase a home was to write a $180,000 check and be done with it, most of us would be relegated to rental status for the rest of our lives. But that line between acceptable household debt and detrimental household debt is growing increasingly blurred. Like ownership, affordability has become a slippery concept.

Today more and more middle-class home owners are discovering that-despite the hard sell they got from their bank or mortgage lender-stretching to buy a home can put them in an exceedingly tight financial state. It used to be a fairly safe rule of thumb that if the bank was willing to offer you a mortgage, no matter what your circumstances, you could probably afford it. Taking out a mortgage was a straightforward endeavor. Your income and credit history were vetted by the local bank or savings and loan, you signed up for a fifteen- or thirty- year fixed-rate mortgage, then you made your monthly payments like clockwork until one glorious day you woke up debt-free. Beyond choosing whether to pay ahead of schedule or take the full span of years to own your house free and clear, there really wasn’t too much choice involved. Shifts in the mortgage and lending industries over the past twenty- five years mean that today it’s become much easier to buy a house, but much harder to hold on to one.

III) Causes — Local Government Laws and Zoning

From the 1990’s to the beginning of the subprime mortgage crisis in 2008, house prices in urban centers in America, increased at a rate of several times the general inflation rate. The trends still show attributes of inflation which had tripled in the span from 1993 to 2007, displaying a yearly increase of around 8%.

We shall investigate and try to deduce why the rates increased at such break-neck rates. The cost of construction could not have been the problem. The consumer price index was growing faster than the construction costs during and after the war, falling well after the period following the 1980’s due to progress in technology in the form of more efficient, less costly, innovative methods of construction leading to employment increase for immigrant workers from factories to on-site. The prices of housing have even decreased in recent years, at a steady rate.

One of the factors that led to this unprecedented rise in house prices during the above mentioned period, could be urban housing supply restrictions imposed by local governments. Both the coasts witnessed record prices and inflation in house prices, which incidentally had the strictest land-use laws and restrictions. Comparatively, the South being the lowest and the Midwest area slightly lower than the coasts.

The local governments now trump the courts in matters of land-use laws thus slowly making the Fifth Amendments rights slowly redundant. Density control is now handled by the local governments, overriding court orders, and in places like Dallas. As much as half of approximately 50 restrictions applicable to a private lot, could be attributed to limit densities in residential areas. Dallas zoning laws require that the building be in complete compliance with local restrictions in case of altered exteriors, even though many of them are ushered in, when restrictions are tightened. Provisions like these override significant improvements in the standing stock of housing.

Zoning laws also cracked down on vertical development, thus encouraging “build out” by property developers. While it can be agreed upon that most sensible residents of a metropolis or city would prefer lower-density, however if he wishes more space he can buy bigger lots. One of the reasons for the breakneck speed of housing price increases have been government restrictions on housing supply thus making prices expensive. This might or might not have been intentional, nevertheless, it did deprive millions of middle-class, low and medium income minority people in stringently controlled areas.

It is relatively simple to impose an upper limit on government interventions in local housing that could significantly improve welfare of residents, if it is the wish of the people to live in lower density residential areas, as compared to competitive housing markets. The further the area is from a commercial center, the lower is the residential density of that area, regardless of restrictions. Sacrificing shorter commute times and distance, residents and simply opt for lower density neighborhoods, if density controls are not applicable. Controls make the situation much worse, if they are so restrictive that they make bigger commutes for the residents if there were not there in the first place. According to recent research, residents welfare are quite low, due to the longer distance commutes they face due to the density control laws.

IV) the Racial Factor and Minorities in Predatory Lending

Minorities are also far more likely to be given subprime loans, targeted toward those with low incomes or bad credit and offered at exorbitant interest rates. Roughly 50% of home loans to black and Hispanic households are subprime, compared to less than one- fifth of those issued to white borrowers. This racial gap between sub- prime and prime lending persists even after controlling for borrower income. A white borrower with an income of less than 80% of area median has about the same likelihood of obtaining a prime mortgage as an African-American borrower with an income in excess of 12.0% of area median.

Banks and lenders are more likely to push subprime loans to middle-class black families, most of who would qualify for a conventional mortgage, than to low-income whites do any of these looser lending policies help individual home buyers? Without question, they get us into homes we couldn’t have afforded thirty years ago. But they also contribute to the rising percentage of the population who pay over 30% of their income toward housing, making them officially ‘house poor.’ The 2005 Census showed strong increases in the number of house poor, not just in major urban centers like New York and Los Angeles but in places like Wyoming, Michigan, Round Rock, Texas, and Plymouth, Minnesota.

Though the bulk of this country’s house poor remain low income, affordability pressures are moving up the income ladder.

The number of house-poor middle-class families more than quadrupled between 1975 and 2001, and the number of middle-income households with severe housing-cost burdens-those paying more than half their income for housing-went up by 707,000 between 2001 and 2004, to a total of 3 billion. If you add in those who are below middle-income, the figure becomes truly staggering, $5.8 million home owners facing a severe housing burden.

It seems the key lesson to take into the home-buying arena today is twofold. First, despite the promises made by college educations, steady jobs, and the American dream, it is possible for a house to be a poor investment, a liability rather than an asset. Second, when it comes to figuring out whether you can afford a house at all, the bank is not necessarily your friend. Banks have been caught pushing subprime mortgages to those who would still qualify for a regular mortgage, and deliberately issuing mortgages to families they knew couldn’t afford to pay them, with the intention of foreclosing then reselling the property.

One of the best things we can do to protect our interests is to educate ourselves on what the various mortgage options mean and the kind of long-term debt we’re actually taking on when we sign that dotted line. We need to examine what sort of income we’ll require not just now but also five, fifteen, thirty years into the future to sustain this fixed and perhaps even escalating debt. And we must take into consideration what would happen if, somewhere down the line, we encountered the very real possibility of changed financial circumstances.

The financial knots we’re tying ourselves into now, as we scramble to purchase homes and wind up owning less of them, can have serious long-term ramifications. Because today’s overall tighter finances often necessitate putting off major purchases, many adults don’t buy their first home until they’re well into their thirties or even forties.

As a result, those thirty-year mortgage payments follow us right into retirement, hanging around even as rising health care and tuition expenses for college-aged children begin to spike. As a result, we discover too late that the asset we gambled everything to acquire because it was going to see us through retirement is instead pushing that retirement further and further away. Already, an increasing number of seniors are borrowing against their homes, accumulating more debt just at the time when they’re supposed to be shaking themselves free. In 1983 only 5% of households headed by someone age sixty-five to seventy-four had debt on a primary residence, and only 3.7% of those age seventy-five and older.

V) “Knee-jerk” reactions to the Unaffordability Crisis

Interest rates fell in the early part of the decade, fell drastically in the United States, giving rise to unparalleled appreciation of home prices. Some of the markets such as the coasts, witnessed astronomical appreciation. In some areas, annual increases were above 10%, while some saw as much as 50% aggregate increases over the last ten years, before the 2008 subprime mortgage crisis.

Some homeowners experienced a windfall of massive capital gains due to this appreciation in values and became millionaires and billionaires. However, this also led to serious unaffordability problems for renters who were looking to buy houses, especially in the coasts, while the rich became richer.

The mortgages were actually more widespread during these times of heavy appreciation, also increasing consumption of properties, which would have been unthinkable otherwise. Non-traditional loan products like subprime mortgages were offered to these low income people, in order to make it more affordable for them, which actually worsened the problem of high appreciation value.

Consumer who could previously think about purchasing and owning homes, were able to take out mortgages, regardless of how low their income was, allowing them to make artificially low monthly payments, despite shot up credit scores. Unknowingly they put themselves at great risk by picking up such loans as we can clearly see now.

There is also the possibility that a few of the mortgage borrowers might have been fraudsters by simply going for it, because they could, even though they knew that they could not afford the house. For instance, it has been uncovered recently that inflated their salaries on fake loans intentionally, used identity theft or simply rented identities of people with higher credit scores, got themselves added to credit cards of people with good credit histories by paying them a flat amount, or purchased fraudulent pay stubs.

First time owners, on the other hand, seemed to be shocked, because of their naivety, unsophistication, upon learning that they would be stuck with their houses and unable to sell after the subprime mortgage crisis hit the economy and the housing market. Refinancing their expensive homes was also not an option available for some, and again they were surprised to be in that position. In the end, the lack of information and disparity of available knowledge to them, might have been the root cause for them ending up with subprime mortgages, and expensive, non-traditional mortgage products which they simply did not understand the terms and conditions of. They might have been simply disqualified in other, more traditional times of the housing market.

The down payment requirement usually deterred people renting homes in low income areas from attempting to become homeowners, because of the nationally low and for extended periods, negative U.S. rates of savings. Several of these people also found that they could not afford the payments every month for the traditional fifteen and thirty year fixed rate mortgages and also they simply could not come up with the hefty down payment requirements. This was the cue for the U.S. government to offer up nontraditional subprime mortgage products in order for these people to change their lives, and thus diversifying the regulated mortgage industry. The lending banks were quick to jump to this opportunity, and came up with exotic or alternative products, and approving previously denied or stalled loan application in droves.

A product in particular, which is led to the collapse of the U.S. subprime mortgage market in 2008, is often blamed to be the main cause. This product started as a traditional 30-year fixed mortgage but with a lower and short-term interest rate, which was very tempting but a ruse to lure the people, which then changed into an ARM after three of four years.

This was a crossbred ARM of sorts. The borrowers monthly payments after the initial years would be reconfigured, based on the rate of interest when the loan rate was reset. The interest rate on these 3/27 and 2/28 were changed invariably over the years.

VI) Basic features of sales and repurchase agreements

Sales and repurchase agreements are deals under which assets are sold by one party to another on terms that provide for the seller to repurchase the asset under certain conditions. Many institutions consider securities borrowing and lending and generally repo operations as being strategically important.

This is particularly true of those able to capitalize on AAA or AA credentials, and those who have access to substantial custodial holdings of customers’ securities.

A variation of a repurchase agreement is an arrangement under which one party holds an asset on behalf of another. Another form of repo is outright forward purchases. They are less common than the more classical repurchase agreements, but the full credit risk remains; therefore it is not considered prudent to offset forward sales against forward purchases in assessing credit risk unless the transactions are with the same party. Even then there may be legal issues to be considered before netting.

Combined with the globality of their operations, the activity in securities borrowing and lending enables financial institutions to deliver more diversified services to customers in different financial markets. This policy capitalizes on the fact that a bank or investor holding an inventory of assets (for instance, bonds) can fund his position in the repo market, doing so either on term or overnight.

Since repurchase will take place on a specified day in the future, this effectively means that the seller is borrowing money. The repo operation connects the underlying cash market and the futures market. The sale price may be market value, but it could also be another mutually agreed price. The difference between the buy-back price and the selling price is, for any practical purpose, the interest. Basically, repurchase agreements are a form of collateralized lending by which one party sells securities and agrees to buy them back in the future at a higher price. For instance, to enhance its liquidity, a bank may be borrowings against U.S. Treasury bonds or bills, mortgage-backed securities, or collateralized mortgage obligations (CMOs) which it holds. These securities are temporarily given by the bank as collateral to the lender, but the bank then retains the right to buy back the securities at a fixed price. The repurchase is usually within a day or two of the ‘sale’, though it may extend over a number of months.

Because typically the resale price is in excess of the purchase price, reflecting an agreed rate of return effective for the period of time the purchaser’s money is at play, it introduces two key variables to the repurchase agreement: the mutually agreed time and price. The repurchase price may:

be fixed at the outset;

vary with the period for which the asset is held by the buyer; or • be equal to the market price at time of repurchase.

The repurchase price can also be calculated to permit the buyer to recover incidental holding costs (such as insurance). Another crucial variable is the nature of repurchase provision. Whether this is an unconditional commitment for both parties, an option for the seller to repurchase (call option), an option for the buyer to resell to the seller (put option), or a combination of put and call, repurchased provisions are integral part of the repo. The repo market is growing steadily although, not exponentially. Market expansion impacts on risk. Therefore, prudent policy must see to it that repurchase agreements are at all times fully collateralized in an amount at least equal to the purchase price, including accrued interest earned on the underlying securities. Instruments held as collateral should be valued daily, and if the value of repo instrument(s) declines, then the bank should ask for additional collateral.

VII) Agreements and Loans Requiring Borrowers to Waive Meaningful Legal Redress

Compulsory arbitration clauses that forbid borrowers from looking for judicial redress, are often enclosed in subprime mortgage agreements. additional clauses prohibit borrowers from taking part class action lawsuits against banks and lenders. Mortgages that do permit borrowers to follow claims in court often shift lenders’ attorneys’ fees against borrowers.

The damage from predatory lending is so harsh that it is essential to ask, What would make homeowners still concur to such one-sided, unfair bargains? Much of the response lies in lenders’ mindful utilization of cognitive irregularities in financial decision-making by home owners.

The only thing tempering this flow of credit is the due diligence exercised by secondary market conduits to ensure that the loans being securitized meet certain standards. These standards, however, are designed to protect investors and do not provide substantial shelter for borrowers’. In fact, securitization frequently serves primarily to remove borrowers’ claims by operation of a legal doctrine called holder in due course, which prevents borrowers from asserting most claims against purchasers of home loans.

Under this doctrine of commercial law, once a loan is sold, purchasers ordinarily cannot be held liable for claims against the original party to the transaction, as long as the purchaser took the loan without knowledge of the existence of such claims.

As the following example shows, this doctrine creates a vacuum in which the borrower has no remedy against certain parties that benefit from the predatory loan. The mortgage process usually proceeds as follows.

The lender, either directly or through a mortgage broker, originates the loan to the borrower. The lender packages the loan with other mortgage loans and sells the loans to a securitizer in the secondary market, and receives payment. The lender may also choose to sell the rights to servicing the loans to the securitizer as well (or to another entity), or the lender may keep the servicing rights and service the loan itself. At this point, if the lender has sold off both the loan and the servicing rights, the lender is seemingly out of the picture, because it has already received its profit. All future cash flows from loan repayment are collected by the servicer, who passes them on, minus its fee, to the MBS investors. Under normal circumstances, there is no problem for the borrower with this process. On the other hand, if the loan is predatory, the process can give rise to significant borrower concerns.

For example, suppose the loan (1) charged an interest rate that was overpriced relative to the borrower’s risk of default, given that the borrower qualified for a prime loan, (2) charged an excessive origination fee and additional discount points, (3) was a brokered loan that was originated at a higher interest rate than the lender required-thus netting a (yield spread) premium for the broker (yield- spread premiums are discussed below, in the section ?Mortgage Brokers and Third-Party Lending, (4) contained an abusive subprime prepayment.

VIII) Mortgage Brokers and Third-Party Lending

Mortgage brokers reportedly account for one-half of all subprime home loan originations. Mortgage brokers usually choose the mortgage lender and the terms of the mortgage for the customer.

For this reason, customers typically perceive mortgage brokers as their “agent” and expect their broker to act in their best interests. Brokers introduce the opportunity for yet another market imperfection, what is referred to as the principal-agent problem in economics.

The agency problem in this case is that the customer (principal) pays the broker (agent) either directly or indirectly, or both, to act in her best interest by securing a suitable mortgage loan, yet the customer cannot completely monitor the actions of the broker. This lack of monitoring provides the broker with an opportunity to operate in conjunction with a third party (the lender) to take advantage of the customer. An additional complication is that the amount of payment the broker receives is determined not by the borrower but by the lender, through the payment of a yield-spread premium. While it is preferable (in theory) from an efficiency standpoint to allow customers to contract out the job of obtaining the mortgage to professionals with greater expertise than theirs, this arrangement allows abusive brokers to steer unsuspecting borrowers into bad loans, aided and abetted by lenders willing and able to pay extravagant yield-spread premiums.

IX) Securities lending has its risks

One of the major roadblocks in the merger of the Mellon Bank with the Dreyfus Fund has been the separated management awareness because of dilemma at Mellon’s Boston Company. This was an asset management firm that Mellon purchased from American Express for $1.4 billion in May 1993. In November 1994, Mellon alleged it would write off $130 million as a consequence of losses on derivatives assets by Boston Company’s business of securities loaning, more willingly than pass the losses on to customers. Dreyfus sources thought these pressures prompted deeper cuts in spending for business development, compensation and technological improvements than either company originally contemplated.

Repurchase agreements with correspondent banks and with hedge funds carry credit risk, since the counterparty can default. They may also be counterproductive in terms of diversification because sometimes they lead to a greater level of exposure to a single name, industry sector and, of course, type of instrument. Credit risk models have not evolved to a point where this type of concentration is taken care of.

X) Role of Credit Default Swaps in the 2008 Subprime Mortgage Crisis

One of the most interesting developments in the financial marketplace over the last decade has been the growth in the volume and diversity of credit derivatives. These are contracts that provide insurance against defaults and therefore allow investors to manage their credit risk. The insurance can be purchased on either a single name or on baskets of securities. These allow investors to buy and sell risks associated with defaults either on a particular entity or on a portfolio. As financial markets have globalized, credit derivatives can now be found in portfolios all over the world. The ability to share risks allows investors to take only the risks they choose to take.

A credit default swap (CDS) provides insurance on a particular reference security. The purchaser pays a periodic coupon (usually quarterly) over the life of the CDS or until there is a default. In the event of a default, the purchaser can sell the defaulted bond of the reference entity for full face value to the CDS seller, or sometimes an equivalent cash settlement is stipulated. The seller receives the periodic premium until a default, at which time he must pay the loss on principal. The cash flows from selling protection are essentially the same as those from owning the reference bond, except that the principal is not exchanged. The size of the premium in CDS contracts is thus fundamentally linked to the probability of default and the recovery rate in case of default. The premium is often called a spread as it is the return above the riskless rate for bearing the default risk.

Models of default are sometimes formulated in terms of a structural model of equity prices and sometime in terms of reduced-form or direct default predictions. The focus here will be on structural models that integrate the concepts developed thus far. Many excellent references discuss the two approaches: Lea, (2010),

Longstaff and Rajan (2008)

implement a reduced-form model on a data set very similar to the one used here. The structural model is based on (Firestone, et al., 2007) and reflects the fact that equity can be viewed as an option on the value of the firm. Default occurs when the price of equity goes to 0 and the bondholders own the remaining value of the firm. More realistically, a default will occur at a low but nonzero value of equity.

Thus it is natural to think of the probability of default as the probability that equity values fall below some default frontier. If the probability of default is known, then the default frontier can be calculated based on models of future equity prices. The market price of CDSs gives a market view of the probability of default. Approximately, the CDS spread divided by the recovery rate is often viewed as the risk-neutral probability of default. Various risk management systems calculate the default frontier from more fundamental considerations and measure the “distance to default” as the distance equity prices would fall at a default. From such an analysis one can calculate the probability of default and the price of a CDS. One can also calculate the risk of a CDS.

The important observation to take from this analysis is the close relationship between default probabilities and equity volatility. If the volatility of equity prices increases, then the probability of crossing any particular default frontier increases. If volatility is asymmetric, then the multiperiod distribution of returns will be negatively skewed and the probability of crossing the default frontier will be higher. Thus models of extreme moves in multiperiod equity returns are at the heart of models of default probabilities and CDS pricing in this structural context.

For investors, the risk of default might be much more manageable if defaults were all independent. In this case, a large portfolio with small investments in many bonds would never face much risk. However, when defaults are correlated, the probability of a large number of defaults occurring is substantial. The derivative contract that provides this insurance is generically described as a collateralized debt obligation (CDO). A CDO is a portfolio of assets of various forms that is sold to investors in various degrees of riskiness. This is accomplished by dividing the portfolio into tranches that differ in seniority. The first losses that occur are attributed entirely to the lowest, or equity, tranche. After a fixed fraction of the portfolio value is exhausted, the next tranches suffer the losses, and so on. After the equity tranche, the next lowest are the mezzanine or junior tranches, and the highest are the senior or super-senior tranches. The mezzanine tranches are more expensive to purchase and have a lower rate of return but also a lower default risk than the equity tranche.

Finally, the senior tranches are the most expensive and receive the lowest return because they are nearly immune from defaults. In this way a portfolio that has some bad loans and some good loans that cannot be distinguished at the beginning can be sorted into high-grade and low-grade investments. Because ratings agencies typically, at least until the summer of 2007, rated the senior and super-senior tranches AAA regardless of the contents of the portfolio, the structure created both investment grade and high-yield paper from any pool of loans. Firestone, et al., (2007) point out the importance of Basel II’s reliance on ratings.

XI) Using repurchase agreements for going short and for other trades

Originally, the practice of borrowing and lending securities was more widespread in the U.S.A., where it has been used for going short in a particular security and for arbitrage between short-term and long-term issues, or for engaging in reverse repurchase agreements with a variety of conditions attached to them.

A short seller typically expects prices to fall and hopes to buy the securities back at cheaper levels. By acquiring securities through a repo transaction, the short seller can deliver them to the buyer while maintaining his bet that the market will fall. Speculation aside, the ability to go short is essential for market-makers because they have to make two-way markets: they must be willing to buy securities they might not own, and to sell securities they do not have at the time of the transaction. Investors may enter into repos for a variety of reasons.

For example, that an investor wants a certain government bond but is short of money with which to buy it; rather than take out a bank loan, it would be cheaper to buy the bond while simultaneously posting it as collateral for a loan. This process is often compared to pawn-broking, but this is for investment and trade reasons; with government paper as security, the lender will charge a lower rate than a bank. The mortgage roll arbitrage model is a variation of repurchase agreements. A writer sells mortgage-backed financing (MBF) instruments to a buyer and agrees to repurchase an equal amount of substantially the same securities at a specified future date and at a set price. In this transaction, the writer/borrower receives cash equal to the spot market price on the opening settlement date in return for the securities. On the closing settlement date, the seller pays the buyer the forward price, and the securities are returned.

The difference between the spot and forward prices (drop) provides the seller’s incentive to enter the roll transaction. The buyer/lender receives the interim cash flows from the securities as compensation for lending the cash. Mortgage rolls benefit sellers and buyers in a similar manner to repos. They allow sellers to convert MBFs into cash at short-term, lower cost funds rate; reinvest the funds for the term of the contract at a higher rate; and earn a spread on the transaction. For their part, the buyers often use rolls to cover their obligations to deliver mortgage securities.

Mortgage rolls differ from repos in that the ownership of the securities is actually transferred and therefore the buyers are entitled to receive the inter-mediate cash flows from these MBF securities. Over and above this, roll buyers need only return substantially similar securities but are under no obligation to give back the identical pools on the repurchase date. One kind of repurchase agreement that grew in popularity is flex, or floating rate repo, with MBFs as collateral. However, the mortgage-backed securities market is less liquid than the U.S. Treasuries market. The two primary considerations in mortgage roll analysis are the cost of carry and the drop. A mortgage roll arbitrage model is needed to determine the profitability of possible roll transactions under different prepayment assumptions, particularly concerning:

the detailing of mortgage security information; and • the provision of arbitrage information of forward drops by a prepayment scenario.

Although each investor has his own information requirements, a sound practice is that results are presented in terms of both arbitrage dollar amount and implied cost of carry, preferably in graphics. A breakeven drop for given market repo rate should be computed for each prepayment assumption. Models permitting experimentation on different scenarios give an advantage to the trader who has access to them. The position taken by the central bank in connection with repurchase agreements and the prevailing rules of the game has a significant impact on the market. The Bank of England was the initial central bank to initiate repos, in 1830. But more lately it limited the freedom of lending or borrowing government bonds to the institutions that were eager to act as gilt-edged market-makers (GEMMs).

They can use gilts to wrap short positions, and are indebted to make two-way prices. Contrasting other central banks the Bank of England also insisted that trades must be settled at home so that it could keep a close eye on the market. Neither did it accept the need to level disparities in the tax treatment of investors. But then, at the end of 1995, the Bank of England opened up the repo market. Why did it change its mind?

Analysts say that one of the reasons is monetary policy. In an open market, reserve banks can use repos to change the level of liquidity. Another reason is probably that a growing number of players, among them hedge funds, now prefer to finance their purchases through repos. A third reason lies in the market’s size. Part of the bet which every central bank of the G-10 is making is that the opening-up of the repo market will attract more investors, especially foreigners, and therefore increase liquidity. In turn this will reduce the government’s borrowing costs. Even today, however, the British gilt repo market is small compared with its foreign counterparts. The French repo market has grown faster than the British, probably because both the French government and the Bank of France have actively encouraged this market’s development. Among other things, they helped to draw up a new contract that made repo transactions easier and more secure. In Germany, the repo market was established in the late 1980s and today about two-thirds of turnover in its government bonds is repos. But most deals are booked in London because, unlike other central banks, the Bundesbank slaps reserve requirements on domestic trades in order to diminish counterparty risk.


The subprime mortgage market disaster carries on to have an overwhelming consequence equally on the American financial system and the American people and their families. Consequently, predatory lending mechanisms and borrowers’ financial naivety, other families are forced to give up their homes every day. Families have been left to understand that their lifelong dreams have turned out to be their most horrible nightmares. Even though the subprime disaster will not be repaired quickly, the government can take instantaneous action by reforming the loan adjustment systems and hoping to reduce prospective losses. In addition, the United States ought to work in the direction of shielding homeowners by ratifying national anti-predatory laws to defend consumers and set up an effectual program to offer potential homeowners with essential financial instruction in order to prevent upcoming crises. The acceptance of these actions will not only assist America dodge the present financial crisis, but will in addition set the base for a stronger financial outlook, where each citizen can have enough money and accomplish and have a piece of the American Dream of owning a house.


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Elliehausen, Gregory and Michael E. Staten. 2004. Regulation of Subprime Mortgage Products: An Analysis of North Carolina’s Predatory Lending Law. Journal of Real Estate Finance and Economics, 29 (4): 411-433.

Dayana Yochim, Need a Loan? No Problem, Credit Center, (last visited May 20, 2012).

See Arthur G. Boylan, the Subprime Mortgage Market.” Its Broad Impact and the Initial Hurdle for Securities Class Actions, 55-AUG FED. LAW. 20 (2008).

Longstaff, F., and a. Rajan. An empirical analysis of the pricing of collateralized debt obligations. Journal of Finance 63:529 — 64. (2008).

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Ron Chernow, the Lost Tycoons, N.Y. TIMES, Sept. 28, 2008, at WK12.

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Souphala Chomsisengphet, Anthony Pennington-Cross; the Evolution of the Subprime Mortgage Market. Federal Reserve Bank of St. Louis, Vol. 88, 2006

News Release, Bureau of Econ. Analysis, Personal Income and Outlays (Nov. 2006), see also Kelly Evans, Hard-Hit Families Finally Start Saving, Aggravating Nation’s Economic Woes, WALL. ST. J., Jan. 6, 2009, at A1.




Stephanie Moulton, Barry Bozeman; the Publicness of Policy Environments: An Evaluation of Subprime Mortgage Lending. Journal of Public Administration Research and Theory, Vol. 21, 2011

News Release, Bureau of Econ. Analysis, Personal Income and Outlays (Nov. 2006), see also Kelly Evans, Hard-Hit Families Finally Start Saving, Aggravating Nation’s Economic Woes, WALL. ST. J., Jan. 6, 2009, at A1.

Adam Tanner, San Francisco Suburb Vallejo Files for Bankruptcy, REUTERS, May 23, 2008;

Howard Lax et al., Subprime Lending: An Investigation of Economic Efficiency, 15 HOUSING POL’Y DEBATE 533, 544-46 (2004),

Nichols, Jospeh, Anthony Pennington-Cross, and Anthony Yezer. Borrower self-selection, underwriting costs, and subprime mortgage credit supply. Journal of Real Estate Finance and Economics 30:197-219. (2005).


Immergluck, D. Credit to the community: Community reinvestment and fair lending policy in the United States. New York: M.E. Sharpe. (2010).


Howard Lax et al., Subprime Lending: An Investigation of Economic Efficiency, 15 Housing Pol’y Debate 533, 544-46 (2004),

Fishbein & Woodall, supra note 19, at 4, 11. See generally Subprime and Predatory Lending, (statement of Sheila C. Bair, Chairman, Fed. Deposit Insurance Corporation); Christie, supra note 39.

OFHEO (Office of Federal Housing Enterprise Oversight). Mortgage markets and the enterprises in 2006. / 62507OFHEOMMEin2006.pdf (accessed May 18, 2012). (2007).

Lea, Michael. Innovation and the cost of mortgage credit: A historical perspective. Housing Policy Debate 7:147-74. (2010).

Longstaff, F., and a. Rajan. An empirical analysis of the pricing of collateralized debt obligations. Journal of Finance 63:529 — 64. (2008).

Chomsisengphet, S., and a. Pennington-Cross. The evolution of the subprime mortgage market. (2006).

Tett, Gillian. Fool’s Gold. New York: Simon & Schuster. 2009.

Firestone, Simon, Robert Van Order, and Peter Zorn. The performance of low income and minority mortgages. Real Estate Economics 35:479-504. (2007).

Adam Tanner, San Francisco Suburb Vallejo Files for Bankruptcy, REUTERS, May 23, 2008;

Fishbein & Woodall.

Michael M. Phillips, to Help Broke Homeowners, He’s Taking the Law into His Own Hands, WALL ST. J., June 6, 2008, at A1.

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