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Lecture Intermediate corporate finance – Chapter 1 (Web extension 1A): A closer look at markets: securitization and social welfare

Chapter 1 (Web extension 1A) - A closer look at markets: securitization and social welfare. The main contents of the dissertation consist of two main parts: the home mortgage industry, securitization in the mortgage industry. | Chapter 1 Web Extension 1A A Closer Look at Markets: Securitization and Social Welfare Topics in Web Extension The home mortgage industry Securitization in the mortgage industry Home Mortgages Before S&Ls The problems if an individual investor tried to lend money to an aspiring homeowner: Individual investor might not have enough money to fund an entire home Individual investor might not be in a good position to evaluate the risk of the potential homeowner Individual investor might have difficulty collecting mortgage payments S&Ls Before Securitization Savings and loan associations (S&Ls) solved the problems faced by individual investors S&Ls pooled deposits from many investors S&Ls developed expertise in evaluating the risk of borrowers S&Ls had legal resources to collect payments from borrowers Problems faced by S&Ls Before Securitization S&Ls were limited in the amount of mortgages they could fund by the amount of deposits they could raise S&Ls were raising money through short-term floating-rate deposits, but making loans in the form of long-term fixed-rate mortgages When interest rates increased, S&Ls faced crisis because they had to pay more to depositors than they collected from mortgagees Taxpayers to the Rescue Many S&Ls went bankrupt when interest rates rose in the 1980s. Because deposits are insured, taxpayers ended up paying hundreds of billions of dollars. Securitization in the Home Mortgage Industry After crisis in 1980s, S&Ls now put their mortgages into “pools” and sell the pools to other organizations, such as Fannie Mae. After selling a pool, the S&Ls have funds to make new home loans Risk is shifted to Fannie Mae Fannie Mae Shifts Risk to Its Investors Risk hasn’t disappeared, it has been shifted to Fannie Mae. But Fannie Mae doesn’t keep the mortgages: Puts mortgages in pools, sells shares of these pools to investors Risk is shifted to investors. But investors get a rate of return close to the mortgage rate, which is . | Chapter 1 Web Extension 1A A Closer Look at Markets: Securitization and Social Welfare Topics in Web Extension The home mortgage industry Securitization in the mortgage industry Home Mortgages Before S&Ls The problems if an individual investor tried to lend money to an aspiring homeowner: Individual investor might not have enough money to fund an entire home Individual investor might not be in a good position to evaluate the risk of the potential homeowner Individual investor might have difficulty collecting mortgage payments S&Ls Before Securitization Savings and loan associations (S&Ls) solved the problems faced by individual investors S&Ls pooled deposits from many investors S&Ls developed expertise in evaluating the risk of borrowers S&Ls had legal resources to collect payments from borrowers Problems faced by S&Ls Before Securitization S&Ls were limited in the amount of mortgages they could fund by the amount of deposits they could raise S&Ls were raising money .