How to survive a mortgage meltdown
Interest rate volatility has left some US mortgage lenders reeling, and it’s dynamic hedging of loan books with swaps that is to blame. By embracing options more, as US mortgage bank Countrywide Financial did, they could have fared much better.
Risk managers at many US mortgage banks are in a tailspin. Six months ago, all appeared to be going well, as gains on their interest rate hedge books added to strong profits from mortgage lending. Receiving fixed rates of interest from swaps was a profitable strategy in a low interest rate environment. Then, in June, the good times came to an end.
Fixed-income markets experienced an unprecedented bout of volatility. Swaptions volatility increased by around 50% (see figure 1). Yields on 10-year
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