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Practice paper

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

Luke Woodward and Sudhakar Raju
Journal of Risk Management in Financial Institutions, 2 (2), 214-225 (2009)
https://doi.org/10.69554/CNLJ5641

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.

Keywords: Alt-A mortgages; mortgage-backed securities (MBS); collateralised mortgage obligations (CMOs); asset-backed securities (ABS); value-at-risk (VAR); subprime mortgages; structured finance

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Author's Biography

Luke Woodward is Assistant Vice President at State Street Corporation, Kansas City, Missouri, where he oversees the domestic transaction processing of repos, equities and commercial paper in the Global Services division..

Sudhakar Raju is Professor of Finance at Rockhurst University in Kansas City, Missouri. He is a graduate of Harvard University and has served as a consultant to organisations like the Chicago Board of Trade and the World Bank.

Citation

Woodward, Luke and Raju, Sudhakar (2009, March 1). The implosion of the Alt-A mortgage-backed securities market. In the Journal of Risk Management in Financial Institutions, Volume 2, Issue 2. https://doi.org/10.69554/CNLJ5641.

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cover image, Journal of Risk Management in Financial Institutions
Journal of Risk Management in Financial Institutions
Volume 2 / Issue 2
© Henry Stewart
Publications LLP

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