Solutions to Improving Subprime Mortgage Risks

By

TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION1

Research Background1

Research Aims and Objectives1

Research Questions1

Theoretical Framework2

CHAPTER 2: LITERATURE REVIEW4

Definition of Subprime4

Subprime Mortgages4

Subprime Lending6

Characteristics of Subprime Mortgage6

Subprime Mortgage Crisis9

CHAPTER 3: METHODOLOGY11

Research Methodology11

Research Plan11

Key Terms11

Qualitative and Quantitative Research12

Interviews13

Data Collection and Processing Procedures13

Ethical Considerations13

Research Contribution14

REFERENCES15

CHAPTER 1: INTRODUCTION

Research Background

Issues that have been faced by the world's economy, developed over a long period. For around a decade or so, a huge amount of money was flowing into United States from foreign investors. This huge influx of money in financial institutions and banks of United States lowered the interest rates and it made easier for the people to get credit. Along with easy credit, it also raised false assumption that the values of homes would continue to rise, led the system towards excesses and bad decisions (Mizruchi & Davis, 2004, 155).

Consequently, the world entered into huge financial crisis, causing panic and turmoil. During subprime mortgage crisis, both the financial institutions and banks increased their kevel of debts significantly. This research will focus on the subprime crisis, to understand the causes and identify its solution.

Research Aims and Objectives

Main aim of this research is to identify solution to improve subprime mortgage risks. This aim will achieve in light with the achievement of the following objectives:

To analyse the causes of subprime mortgages crisis

To analyse various risks involved with subprime mortgage.

Research Questions

What are the causes of Subprime mortgage crisis?

What are the risks of Subprime Mortgage?

Theoretical Framework

Published research in mortgage modeling falls into two broad categories: empirical studies and theoretical development. Empirical models use past behavior to draw inferences about key inter-relationships, in order to create, forecasting models. Theoretical models try to formulate the behavior of borrowers independent of specific regional, economic and sociologic conditions. These types of models provide a general understanding that is applicable to a broad range of situations and conditions that borrowers might face (Zandi, 2009, 20).

Theoretical models try to formulate the borrowers' behaviour mainly based on option theory. This theory assumes that borrowers try to maximize their wealth by hedging or mitigating their losses. Theoretical models display the relationship between borrower behaviour and economic conditions. However, their accuracy is questionable.

Theoretical models in mortgage literature are mostly based on option theory. This work formulated the optimal strategy for valuing stock options. Subsequent researchers build mortgage valuation models using the option theory. One of the key assumptions of these models is that the borrower always uses an optimal strategy in order to maximize his/her wealth. However, this is not the case in real life (Zandi, 2009, 20). Borrowers face "frictions" that are difficulties in exercising optimal strategies for several reasons such as loss of job, no cash availability for an optimal refinancing opportunity, sentimental ownership towards the real estate and free-rent opportunity when the optimal strategy is to default and leave the house. Researchers strive to identify and implement these frictions in models in order to enhance the option theoretic framework and make it more realistic.

Another important aspect presented of these theoretical models by Zandi (2009) is that ...