The implosion of the Alt-A mortgage-backed securities market

Abstract

While the demise of the subprime mortgage-backed securities (MBS) market has received a great deal of attention, the implosion of the Alt-A MBS market has so far received much less attention. As recently as June 2007, annual issuance of Alt-A backed securities exceeded issuance of subprime-backed securities. The outstanding amount of Alt-A securities poses a significant systemic risk that is already becoming evident. This paper identifies the underlying causes for the deterioration of Alt-A MBS pools. While the deterioration in the subprime mortgage market was caused by lending to borrowers with poor credit, the Alt-A crisis was caused by lending to borrowers with fairly good credit who assumed excessively speculative, leveraged positions in overvalued housing markets. The paper applies value-at-risk to demonstrate that Fannie Mae's capitalisation was completely inadequate given the size of its subprime and Alt-A portfolios and its underlying loss expectations. As many of the Alt-A loans are adjustable-rate mortgages that will reset in 2009 and are moreover concentrated in the most overpriced housing markets, even more delinquencies and write-offs of Alt-A securities are in the offing.