With the biggest mortgage lender in the US, Countrywide, announcing record losses for the third quarter in October, industry participants might wonder how the industry ever got itself into this mess. Indeed, the mortgage world seems to have a habit of intermittent crises. Before the subprime experience there was the US savings and loan crisis in the 1980s, for example. One speaker at Mortgage Risk's US conference in October even wondered out loud whether there might be something fundamentally wrong with the asset class or the industry.
There are certainly elements that make mortgages inherently tricky. Models created to predict the performance of loans are conceived in terms of historical experience. When reality starts to divert from the past, those models break down. Because predicting the performance of the asset is part art part science, there is also a danger that lenders begin to rely on ideas that turn out to be wrong. One wrong idea, it seems now, was that a limited number of key numbers such as Fico scores and loan-to-value ratios might determine the credit risk of a loan.
Perhaps most of all, the size of the mortgage market encourages the development of products built around faulty thinking, with CDOs the prime example. The development of the CDO model was based ultimately on views held by Wall Street and, in particular, the rating agencies, which turned out to be faulty. By the time that became clear, an industry had grown up around those assumptions.
Yet the subprime story ceased to be only about subprime some months back. The latest news about rising delinquencies has often been pushed further into the background by the broader liquidity crunch - the de-leveraging that many in the market had been anticipating for some time.
It is the unwinding of leverage in the form of structured investment vehicles that has led to a long-term readjustment of the investor base for mortgage securities, rather than simply the lax underwriting of subprime mortgages (however bad that might have been).
This month, Mortgage Risk looks at issues affecting the future for the industry: where markets are recovering and where not, how the legislative response to the subprime crisis is panning out, and how technology providers are responding to the challenges of credit scoring going forward. As always, we welcome your comments on the magazine and encourage you to email us with suggestions for future coverage.
- Rob Mannix, Editor.
The week on Risk.net, July 7-13, 2018Receive this by email