And all of it, every last part of this looming economic disaster, was due to a unique financial instrument called the mortgage-backed security. Mortgage-backed securities MBSs are simply shares of a home loan sold to investors. They work like this: A bank lends a borrower the money to buy a house and collects monthly payments on the loan.
This loan and a number of others -- perhaps hundreds -- are sold to a larger bank that packages the loans together into a mortgage-backed security. The larger bank then issues shares of this security, called tranches French for "slices" , to investors who buy them and ultimately collect the dividends in the form of the monthly mortgage payments. These tranches can be further repackaged and sold again as other securities, called collateralized debt obligations CDOs. Home loans in were so divided and spread across the financial spectrum, it was entirely possible a given homeowner could unwittingly own shares in his or her own mortgage.
The levels of aggregate over-estimation substantially differed among originators and the variations explained the performance differences between originators.
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The ratings issued by rating agencies failed to capture the adverse impact from over-estimation on CMBS performance. The second chapter of my dissertation studies the CMBS credit rating market using a strategic interaction model. The financial crisis that arose in the mortgage market has brought renewed attention to the failure of the credit rating mechanism.
This chapter models the CMBS credit ratings as strategic behaviors that reflect the peer effects from other rating agencies. We establish semiparametric identification of the model by exploiting an exogenous equilibrium shift due to the financial crisis.
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Moreover, the model is estimated using a two-step estimation procedure. The empirical results strongly support the presence of positive peer effects. By including peer effects, the fitness of our model has been significantly improved. November 24, Oc tober , p. September , p.
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There are two k i n d s of prepayments - f u l l prepayments and p a r t i a l prepayments. Capozza and George W.
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P a r t i a l Prepayments and Prepayment Provision Another very important, but usually neglected factor that can have substantial impacts on the p a r t i a l prepayment behaviors of a homeowner i s the prepayment provision i n the mortgage contract. The prepayment provision put an upper l i m i t on how much p r i n c i p a l the MBS investors have to take back without receiving any additional benefit. The prepayment provision also dictates how much a homeowner can prepay h i s mortgage without penalty at any p a r t i c u l a r time.
Penalties w i l l lower the return of the prepayment from the stand point of the homeowner. There are usually two sections i n a prepayment provision that can a f f e c t a homeowner's p a r t i a l prepayment behaviors. These are the sections that d i c t a t e how much a homeowners can increase the amount of h i s monthly payment and pay down the outstanding p r i n c i p a l balance annually.
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The mortgagee w i l l usually allow a homeowner to increase h i s monthly payment once a year. The increment w i l l usually be between ten and one hundred percent of the contracted monthly payment. In addition to that, the mortgagee w i l l usually allow a homeowner to reduce his outstanding p r i n c i p l e balance by a lump sum payment of ten Capozza and Gau. Two s e t s o f investment t a c t i c s can be developed from these knowledge.
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