Mortgage Subprime Mortgage Crisis 3

Question 1

What is 'negative amortization' and how did it contribute to the subprime mortgage crisis?

Accepted Answer

Loan balances grow when payments don't cover accruing interest, leaving borrowers deeper in debt

Answer

Negative amortization loans allowed minimum payments below the interest due, causing loan balances to increase and borrowers to owe more than the home's value when prices dropped.

Question 2

What was the Emergency Economic Stabilization Act of 2008 primarily designed to do?

Accepted Answer

Authorize the Treasury to purchase toxic mortgage assets through the TARP program

Answer

The Emergency Economic Stabilization Act created the $700 billion Troubled Asset Relief Program (TARP), giving the Treasury authority to buy distressed mortgage-backed securities.

Question 3

How did collateralized debt obligation (CDO) squared products increase systemic risk during the subprime crisis?

Accepted Answer

They repackaged existing CDO tranches into new securities, obscuring underlying mortgage risk

Answer

CDO-squared products pooled lower-rated CDO tranches into new securities, creating extreme complexity that masked the true concentration of subprime mortgage exposure.

Question 4

What does the term 'underwater mortgage' mean, as commonly used during the subprime crisis?

Accepted Answer

The outstanding loan balance exceeds the current market value of the home

Answer

An underwater (or 'upside-down') mortgage means the borrower owes more than the home is worth, eliminating equity and making refinancing or selling at a profit impossible.

Question 5

Which rating agency practice most directly contributed to inflated ratings on subprime mortgage-backed securities?

Accepted Answer

The issuer-pays model, where securities issuers paid rating agencies for ratings

Answer

The issuer-pays model created conflicts of interest because Moody's, S&P, and Fitch competed for business from the very banks whose products they rated, incentivizing favorable ratings.

Mortgage Practice Test

Mortgage Practice Test

Mortgage Subprime Mortgage Crisis 3