Tuesday, February 7, 2012

A Mortgage in the State of Nature?

Nick Rowe writes US fixed rate mortgages aren’t fixed rate mortgages; they are weird, stupid, and dangerous. It’s a good discussion, especially in the comments.

For the bond nerds in the audience, Nick thinks they are stupid because they are callable (can be prepayed) which creates negative convexity, which is dangerous with a fixed rate.

It’s interesting, one of the reasons investors desired subprime was that it was believed to be more stable on the prepayment front; everyone was looking at interest rate risk instead of credit risk, and while the former was fine the second exploded (a situation relevant to Fannie as well, as John Hempton points out). I’ll have more to say on this when we start to dig into housing reform, but I just want to point this out for now. Read more....

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