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UGA FHCE 3100 - Housing and Bonds

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FHCE 3100 Lecture 20 The Housing Bubble House bubbles may occur in local or global real estate markets. They are typically characterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes. How did the housing bubble develop? Also going on at this time was the slow recovery from the 2001 recession This le the Feeral Reserve Board to cut interest rates in an effort to stimulate the economy  Fixed-rate mortgages as well as other interest rates hit 50 year lows. This was a huge incentive tobuy a home. Some statistics of the housing bubble Home ownership rate increased from 64% in 1994 to an all-time high of 69% in 2004  Between 1997 and 2006, the price of the typical American house increased by 124% In 2008, the national median home price was 4.6 times the national median household income Housing boom: lead banks to offer additional risky mortgage products Higher interest rate loans for credit challenged buyers These are fondly referred to as “predatory lending practices” Types of predatory lending Lender charges an excessive interest rate on a loan made to a person with excellent credit  “Loan targeting”—loans target a specific population or group of people Lender continually encourages you to refinance, thus incurring additional fees Refinancing is getting a new loan at a lower interest rate, the lender wants you to do this butit is not in your best interest Blacks and Hispanics are targeted Subprime mortgage loans  Loans given to households with poor credit history. They almost always have a higher than average interest rate.  Subprime market grew from $210 billion in 2001 to $625 billion in 2005  Fannie and Freddie waiting to take bad mortgage out of banks’ hands, so no incentive to help you, bank will give loans to these people even though bad credit 2005 was the peak of subprime boom—1 of 5 mortgage was a subprime  No income, no job, or assets (NINJA) So banks are giving these people loans because they know Freddie and Fannie will take it out of their hands and bank wont be the one stuck with debt if they don’t pay their mortgage The run to the housing collapse  The mortgage and credit crisis was caused by the inability of a large number of home owners to pay their mortgages as their low introductory-rate mortgages (ARMS) reverted to regular interestrates  Fannie and FreddieThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute. They do NOT directly lend to home purchasers. They are in the business of loan securitization  They buy loans from banks; thus the local banks can lend more money to sketchy customers They then bundle the mortgages and resold the loans to investors as a Mortgage Backed Security They held about 75% of American’s mortgages before the collapse!  What happens to your mortgage when F and F buy it? After mortgage is bought it is usually put into a group with others into a MBS Becomes problematic when homeowners cant pay  MBS A type of investment that represent claims to the cash flows from pools of mortgage loans, most commonly on residential property  They are purchased from banks, mortgage companies or mortgage brokers and then assembled into pools  The entity then issues securities (typically bonds) that represent claims on the principal and interest payments made by borrowers on the loans in the pool, “securitization”  MBS = Bonds  The most basic type are pass-through participation certificates (BONDS) which entitle the holder to a share of all principal and interest payments made by the mortgage holder  Bonds… A debt investments in which an investor loans money to an entity that borrows the funds for a defined period of time at a fixed interest rate Investors who bought MBSs loaned money to Freddie and Frannie to buy up more mortgages… BONDS HAVE TO BE REPAID BY THE DEBTOR  But F and F didn’t have enough to repay…so we paid this with our tax dollars  It was believed that these bonds were safe investments since home prices were on the rise One of the major problems that came from the crisis was that billions of dollars were lost in mortgage backed securities  Investors continued to buy these mortgage backed securities b/c they continued to make a great amount of money  The ratings of MBS began to decline Many companies went out of business (Lehman Brothers, Merrill Lunch, Countrywide) The federal reserve began guaranteeing loans to banks to prevent an all out financial failure  Mortgage defaults led to the collapse and government rescue of Fannie and Freddie  Buy 2010, Fannie Mae and Freddie Mac cost taxpayers close to $150 billion; final estimates from that time have the total cost somewhere near $400 billion up to $1 trillion dollars  SO as this collapse happens…ARMS “reset” to their higher interest rate, making people not able to pay their mortgage Default Essentially means a debtor has not paid a debt which he is required to have paid (*behind on your payments)  Foreclosure Cant pay your mortgage, the creditor will respond with a foreclosure is a legal process in which a lender attempts to recover the balance of a loan from a borrower  In all, 3.1 million households submitted foreclosure filings in 2008, or one in every 54 households Living in a an area with multiple foreclosures can result in a 10 to 20% decrease in property


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