Funding of Subprime Residential Mortgage Loans via Marketable Securities and Deposits

B. De Waal, M.A. Petersen, M.C. Senosi, J. Mukuddem-Petersen, and I.M. Schoeman (S. Africa)


Subprime Residential Mortgage Loans (RMLs), Mar ketable Securities, Deposits, Stochastic Model, Residential Mortgage Loan Reference Process, Deposit Reference Pro cess.


The subprime mortgage crisis (SMC) is an ongoing hous ing and financial crisis that was triggered by a marked in crease in mortgage delinquencies and foreclosures in the U.S. It has had major adverse consequences for banks and financial markets around the globe since it became apparent in 2007. In this conference paper, we examine an origina tor’s (OR’s) nonlinear stochastic optimal control problem related to choices regarding deposit and marketable secu rities inflow rates. Here, the primary aim is to minimize deposit inflow rate risk and credit crunch risk. In this re gard, we consider reference processes for subprime resi dential mortgage loans (RMLs) and deposits and use actu arial cost methods in order to find an optimal level of RML extension and deposits for funding this extension. We con clude that there is a positive correlation between an OR’s deposits, marketable securities and subprime RML exten sion. We also show that unfunded RMLs are directly pro portional to additional deposits when employing a spread method of RML financing via deposits and marketable se curities. OR’s required capital reserves are found to be far less than needed as a result of RML securitization.

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