Mortgage Subprime Mortgage Crisis 4 — Questions and Answers
Question 1: What was the 'teaser rate' strategy used in many subprime adjustable-rate mortgages?
- An artificially low initial interest rate that reset sharply higher after one to three years (Correct answer)
- A discount offered to borrowers who paid two points upfront at closing
- A guaranteed rate cap that prevented interest from exceeding a set ceiling
- A promotional rate available only to borrowers with 20% down payments
Correct answer: An artificially low initial interest rate that reset sharply higher after one to three years
Teaser rates made loans appear affordable at origination but reset to much higher rates after an introductory period, causing payment shock and mass defaults when home values fell.
Question 2: What was the primary reason mortgage servicers often preferred foreclosure over loan modifications during the crisis?
- Servicer fee structures and contractual obligations to MBS investors made modifications financially unattractive (Correct answer)
- Federal law prohibited servicers from modifying loan terms without court approval
- Foreclosure was cheaper to execute than modifying a loan in all circumstances
- Servicers lacked the legal authority to contact delinquent borrowers
Correct answer: Servicer fee structures and contractual obligations to MBS investors made modifications financially unattractive
Servicer compensation was tied to collecting payments and foreclosure fees, while pooling and servicing agreements often restricted modifications, creating perverse incentives against helping borrowers.
Question 3: What is 'robo-signing' as it came to light after the subprime crisis?
- Bank employees signing foreclosure documents en masse without reviewing them, often fraudulently (Correct answer)
- An automated system that approved mortgage applications without human review
- Software that electronically signed closing documents on behalf of absent borrowers
- A program that automatically generated credit scores without human oversight
Correct answer: Bank employees signing foreclosure documents en masse without reviewing them, often fraudulently
Robo-signing involved bank employees or contractors signing thousands of foreclosure affidavits per day without reading them, leading to a national foreclosure freeze and major bank settlements.
Question 4: What was the Community Reinvestment Act (CRA), and how was it incorrectly blamed for the subprime crisis?
- A 1977 law encouraging lending to low-income areas that critics blamed but studies found accounted for a small fraction of subprime loans (Correct answer)
- A law that mandated 20% of all bank loans be made to subprime borrowers
- A federal program that guaranteed repayment of all loans made in underserved communities
- A rule requiring banks to lower credit standards for all applicants equally
Correct answer: A 1977 law encouraging lending to low-income areas that critics blamed but studies found accounted for a small fraction of subprime loans
The CRA encouraged banks to lend in all communities they served, but studies found CRA-covered lenders made a small proportion of subprime loans and had lower default rates than non-CRA lenders.
Question 5: What was the HARP (Home Affordable Refinance Program) created to address?
- Helping underwater homeowners with Fannie/Freddie-backed loans refinance at lower rates (Correct answer)
- Providing cash grants to first-time homebuyers in foreclosure-heavy neighborhoods
- Allowing banks to write off bad mortgage debt on their balance sheets tax-free
- Creating a federal fund to purchase and demolish vacant foreclosed homes
Correct answer: Helping underwater homeowners with Fannie/Freddie-backed loans refinance at lower rates
HARP, launched in 2009, allowed homeowners with little or no equity in Fannie Mae or Freddie Mac loans to refinance at lower interest rates, reducing monthly payments and default risk.
Question 6: Which investment bank's collapse in March 2008 is often cited as an early warning signal of the subprime crisis's severity?
- Bear Stearns (Correct answer)
- Goldman Sachs
- Morgan Stanley
- Merrill Lynch
Correct answer: Bear Stearns
Bear Stearns collapsed in March 2008 and was acquired by JPMorgan Chase with Fed assistance, signaling how deeply subprime losses had penetrated major financial institutions.
Question 7: What is a 'jumbo' mortgage, and how did jumbo loans behave differently in the subprime crisis?
- Loans exceeding conforming loan limits that couldn't be sold to GSEs and faced tighter credit markets (Correct answer)
- Mortgages with unusually large monthly payments regardless of loan size
- Government-backed loans for multifamily properties with more than four units
- Loans made to borrowers with credit scores above 800 at preferential rates
Correct answer: Loans exceeding conforming loan limits that couldn't be sold to GSEs and faced tighter credit markets
Jumbo loans exceeded GSE conforming limits and relied on private securitization markets, which froze during the crisis, making jumbo financing scarce and expensive even for creditworthy borrowers.
Mortgage Subprime Mortgage Crisis 4
What was the 'teaser rate' strategy used in many subprime adjustable-rate mortgages?