Douglas A. McManus

Does Mortgage Hedging Raise Long-Term Interest Rate Volatility?

An examination of the impact of mortgage hedging activities on interest rate volatility considers a wide range of interest rate derivatives to isolate the sources that might be contributing to volatility. Over a rolling window providing estimates of key parameters, the measured effects of mortgage hedging on volatility are distorted by two outlier episodes: the collapse of Long-Term Capital Management, and the market reaction in the aftermath of the September 2001 events. Eliminating these episodes from the data shows that hedging appears to stabilize rate volatility over some periods while exacerbating it in others. The conclusion: that no simple relationship between hedging and rate volatility is clear.

The HAMP NPV Model Development and Early Performance

The foreclosure crisis that began in 2008 triggered the need for new approaches to treat distressed mortgages. A key component of the Obama Administration’s Home Affordable Modification Program (HAMP) was the development of a standardized Net Present Value (NPV) model to identify troubled loans that were value-enhancing candidates for payment-reducing modifications. This paper discusses the development of the HAMP NPV model, its purpose, and some important constraints that dictated its structure and limitations. We describe the structure and the estimation of the model in detail. Furthermore, we describe the responsiveness of the model to key characteristics, such as loan to value and credit score and provide new evidence on the relationship between HAMP modification performance and key borrower and modification characteristics. The paper concludes with a discussion of model limitations and suggestions for further refinement of the model.

Residential Mortgage Credit Derivatives

As the fallout from subprime losses clearly demonstrates, the credit risk in residential mortgages is large and economically significant. To manage this risk, this article proposes the creation of derivative instruments based on the credit losses of a reference mortgage pool. We argue that these derivatives would enable banks to retain whole loans while also enjoying the capital benefits of hedging the credit risk in their mortgage portfolios. In comparisons of hedging effectiveness, the analysis shows that instruments based on credit losses outperform contracts based on house price appreciation.

Spillover effects of continuous forbearance mortgages

This paper examines the potential market impacts of continuous forbearance mortgages (CFM). This mortgage design embeds an insurance contract at origination that reduces the interest bearing balance to the smaller of the unpaid balance and an estimate of the current home value in exchange for an additional premium in the mortgage note rate. Thus the CFM mortgage payment is reduced in periods in which the estimated home value falls below the unpaid balance and is reduced fractionally based on the ratio of home value to loan balance. We consider a counterfactual in which all U.S. mortgages had this CFM feature at the start of 2006 and estimate the mortgage payment savings to borrowers at a loan level. Estimated mortgage payment savings are then used to estimate the effect on mortgage default. At the aggregate level, the sum of the mortgage payment savings at the state level is used to estimate potential impacts to regional employment.

Measuring Total Mortgage Market Credit Risk

This paper proposes two measures of credit risk for the population of outstanding mortgages. The first uses an average ex ante default probability to characterize risk, the second uses the unexpected loss generated by the asymptotic single factor risk (ASFR) model, a probabilistic model of portfolio risk. Both approaches show that average market–wide expected default rate and the unexpected loss per dollar of outstanding mortgage balances were roughly constant during the 2002-2006 boom in US house prices.