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Pricing & Distribution of Mortgages and MBS with a look at consumer welfare

Pricing & Distribution of Mortgages and MBS with a look at consumer welfare. What is consumer financial welfare?. Maximize benefit from dollar spent No unneeded services Fee for debit card when you don’t use one Lowest interest rates appropriate Why not lowest available?

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Pricing & Distribution of Mortgages and MBS with a look at consumer welfare

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  1. Pricing & Distribution of Mortgages and MBS with a look at consumer welfare

  2. What is consumer financial welfare? • Maximize benefit from dollar spent • No unneeded services • Fee for debit card when you don’t use one • Lowest interest rates appropriate • Why not lowest available? • Minimize time and opportunity costs • Decision making easy • Little time resolving problems • Satisfaction

  3. An unknown player in the Subprime Crises: Mortgage Servicers • Collects and records the borrower’s principal and interest payments and distribute payments to individuals and firms who purchase Mortgage Backed Securities (MBS) • Collects, records, and distributes escrow payments –property taxes and homeowners’ insurance • What is escrowed? Why? Who is paid escrowed funds?

  4. How the Secondary Mortgage Market Works • Hundreds of mortgage loans are bundled together, recombined, and sliced up to form various types and grades of asset-backed securities which are then bought and sold • Investments vary from the very lowest risk rating (AAA) to high risk, “bottom-rung” investment • 90% of home loans are sold • Important because they help distribute $$ across the US and thus, reduce overall mortgage interest rates (about 1/2 %) • Is ½ % a lot? • Who provides the money for these securities?

  5. Players, Terms and Processes • Consumer • Loan originator (bank) • Frannie Mae/Freddie Mac, etc. • MBS • Credit rating agency • MBS investor • Mortgage Servicer • Principal, Interest, Escrow (homeowner’s insurance and property taxes) • Credit Default Swap • Insurers (e.g., AIG)

  6. Size of these things • “The CDS market exploded over the past decade to more than $45 trillion in mid-2007, according to the International Swaps and Derivatives Association. This is roughly twice the size of the U.S. stock market (which is valued at about $22 trillion and falling) and far exceeds the $7.1 trillion mortgage market and $4.4 trillion U.S. treasuries market” • Time magazine, March 17, 2008 http://www.time.com/time/business/article/0,8599,1723152,00.html • 850 billion in credit card debt (http://www.cnn.com/2008/LIVING/personal/09/25/money.pushers/index.html )

  7. Potential Solutons • 85 B AIG • 29 B Bear Stern • 200 B to Frannie Mae and Freddie Mac • 700 B to allow Fed to buy up failing securities • How much being spent per US citizen? • Issues: • Allow Bankruptcy courts re-negotiate loan agreements (can’t right now because servicer can’t change the contract) • US Take ownership in failed firms • Pricing of failed securities • Oversight of US Treasury Actions

  8. The Rescue Package Passed Oct 1. • “buy up to $700 billion of troubled assets from financial institutions. Those assets, mostly mortgage-related” • “temporarily raising the FDIC insurance cap to $250,000 from $100,000.” • It includes tax breaks • “It would extend a number of renewable energy tax breaks for individuals and businesses, including a deduction for the purchase of solar panels.”

  9. “Senate would only allow the Treasury access to the $700 billion in stages, with $250 billion being made available immediately.” • “Direct the president to propose a bill requiring the financial industry to reimburse taxpayers for any net losses from the program after five years.” • The “Treasury would be allowed to take ownership stakes in participating companies.” • place curbs on executive pay for companies selling assets or buying insurance from Uncle Sam

  10. Finally, it sets “up two oversight committees. A Financial Stability Board would include the Federal Reserve chairman, the Securities and Exchange Commission chairman, the Federal Home Finance Agency director, the Housing and Urban Development secretary and the Treasury secretary.” AND • “A congressional oversight panel” • All quotes from ccn.com Reporter: Jeanne Sahadi • http://money.cnn.com/2008/10/01/news/economy/senate_rescuebill2/index.htm?cnn=yes

  11. Paulson’s Wed, Nov 12 statement regarding TARP funds* • “We announced a plan on October 14th to purchase up to $250 billion in preferred stock in federally regulated banks and thrifts. By October 26th we had $115 billion out the door to eight large institutions. “ * All copied from: http://www.ustreas.gov/press/releases/hp1265.htm

  12. Future Priorities • “First, we must continue to reinforce the stability of the financial system, so that banks and other institutions critical to the provision of credit are able to support economic recovery and growth…. • Second, the important markets for securitizing credit outside of the banking system also need support. Approximately 40 percent of U.S. consumer credit is provided through securitization of credit card receivables, auto loans and student loans and similar products… • Third, we continue to explore ways to reduce the risk of foreclosure.”

  13. What FDIC Proposed Thursday, Nov 13. • http://www.fdic.gov/consumers/loans/loanmod/index.html • What is Congress talking about this week: • Auto bailout

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