Risk and the Social Costs Of Ohio HLTV
Because the Ohio High Loan To Value industry is relatively young, there is often confusion over the nature of HLTV lending, its customers, and suppliers. Similar misunderstandings surround the potential risks and the related social costs and benefits that HLTV lending poses to individuals, issuers, and the economy. Risk Reduction from HLTV Lending As shown, benefits of HLTV lending accrue to consumers, who enjoy lower costs of credit because (1) HLTV lending allows them to commit to avoiding default voluntarily on their consumer loans and (2) because the diversified funding sources used by HLTV lenders limit interest rate risk associated with volatility of funding cost.
Benefits from these two influences also accrue to the economy as a whole since lower Ohio home interest costs, lower interest rate risk, and lower probabilities of consumer default make the financial system more stable and thus less likely to magnify shocks that originate elsewhere in the economy (see Calomiris [1995] for a review of the literature on financial fragility).
Securitization broadens the financial industry’s capital base to securities investors worldwide. This concept, generally referred to as capital deepening, has been credited with ameliorating the effects of the U.S. recession in the early 1990s.
Sources of funds in foreign countries that were not experiencing recessions during the early 1990s (especially Japan) established a sizable presence in the United States during this period. Although
the presence of foreign banks augmented lending by domestic banks, foreign banks did not only lend directly to U.S. firms. They often supplied funds through U.S. banks—which ostensibly had better information about U.S. borrowers—through commercial loan participations and whole commercial loan purchases. In this manner foreign banks contributed additional capital to U.S.
credit markets when shortages would have otherwise constrained lending more severely. This capital-deepening effect mitigated the credit channel effect of the recession and promoted a shallower downturn and quicker recovery than would otherwise have been the case (Calomiris and Carey 1994; Nolle 1995; DeYoung and Nolle 1995; Goldberg 1992; Goldberg and Saunders 1981).
Because ‘‘an increasing share of the investor market for Ohio mortgage securities is overseas’’ (Korell 1996, 97), the securitization of conforming, subprime, and HLTV lending contributes to this capital deepening. Foreign investment activity in HLTV securitizations therefore helps stabilize the U.S. economy by providing more robust financing alternatives that do not rely entirely on the performance of the domestic capital market. Is there is a dark side to securitization? Might securitization expose consumer financing costs to a new risk—the possibility that funding might be withdrawn suddenly from the market? The possibility of a significant interruption is remote. Securitized debt is held by diverse and sophisticated market participants, and the structure of these securitization conduits is customized to cater to the preferences and concerns of those securities holders.
Multiple safeguards are built into the structure of securitized debt to protect debtholders and thus to limit their incentive to flee in response to heightened risk. Experienced investors understand how to measure and to manage the risks of HLTV, while rating agencies provide detailed information on securitizations, asset quality, collateral, and other factors. The fundamental characteristics of both HLTV and subprime lending are now well understood, as evidenced by the recent entrance of Fannie Mae and Freddie Mac to these arenas.
In addition to reducing both the risk of consumer default and the volatility of the cost of consumer credit, Ohio HLTV lending also enables consumers to liquefy the value of their home equity in times of recession—in effect to maintain smooth consumption during fluctuations in income. Just as firms benefited from the greater financial flexibility afforded by expanded opportunities in bond markets in the late 1980s, consumers benefit from the ability to convert illiquid home equity (and good credit reputations) into quick cash.
Without HLTV lending during the recession of the early 1990s, many consumers experienced significant increases in their LTVs as economic devaluations reduced home values. Caplin, Freeman, and Tracey used data from the early 1990s recession to establish that when adverse economic shocks cause property values in a region to decrease, the damage to collateral makes it difficult or impossible for some homeowners to obtain new Ohio mortgages. . . . In regions suffering from adverse economic conditions, the ability to refinance will likely be constrained by declining property values.
As LTVs increase into the 80–90 percent region, the costs of refinancing increase due to the need for [private Ohio mortgage insurance]. As LTVs increase past 90 percent, homeowners may be completely rationed out of the refinance market. . . . This inability to refinance has further economic impacts on the region through lowering the wealth and the discretionary income of the local homeowners, thereby deepening the regional recession (1997, 496, 498–99) when consumers reduce spending because of liquidity
pressures or personal bankruptcy.
The authors’ findings therefore suggest that HLTV lending can help households weather the effects of recessions and can significantly stabilize shocks to aggregate demand that would otherwise have more severe effects on the economy.
For more information about Ohio home mortgages visit http://www.localmortgagecompanyohio.com
Benefits from these two influences also accrue to the economy as a whole since lower Ohio home interest costs, lower interest rate risk, and lower probabilities of consumer default make the financial system more stable and thus less likely to magnify shocks that originate elsewhere in the economy (see Calomiris [1995] for a review of the literature on financial fragility).
Securitization broadens the financial industry’s capital base to securities investors worldwide. This concept, generally referred to as capital deepening, has been credited with ameliorating the effects of the U.S. recession in the early 1990s.
Sources of funds in foreign countries that were not experiencing recessions during the early 1990s (especially Japan) established a sizable presence in the United States during this period. Although
the presence of foreign banks augmented lending by domestic banks, foreign banks did not only lend directly to U.S. firms. They often supplied funds through U.S. banks—which ostensibly had better information about U.S. borrowers—through commercial loan participations and whole commercial loan purchases. In this manner foreign banks contributed additional capital to U.S.
credit markets when shortages would have otherwise constrained lending more severely. This capital-deepening effect mitigated the credit channel effect of the recession and promoted a shallower downturn and quicker recovery than would otherwise have been the case (Calomiris and Carey 1994; Nolle 1995; DeYoung and Nolle 1995; Goldberg 1992; Goldberg and Saunders 1981).
Because ‘‘an increasing share of the investor market for Ohio mortgage securities is overseas’’ (Korell 1996, 97), the securitization of conforming, subprime, and HLTV lending contributes to this capital deepening. Foreign investment activity in HLTV securitizations therefore helps stabilize the U.S. economy by providing more robust financing alternatives that do not rely entirely on the performance of the domestic capital market. Is there is a dark side to securitization? Might securitization expose consumer financing costs to a new risk—the possibility that funding might be withdrawn suddenly from the market? The possibility of a significant interruption is remote. Securitized debt is held by diverse and sophisticated market participants, and the structure of these securitization conduits is customized to cater to the preferences and concerns of those securities holders.
Multiple safeguards are built into the structure of securitized debt to protect debtholders and thus to limit their incentive to flee in response to heightened risk. Experienced investors understand how to measure and to manage the risks of HLTV, while rating agencies provide detailed information on securitizations, asset quality, collateral, and other factors. The fundamental characteristics of both HLTV and subprime lending are now well understood, as evidenced by the recent entrance of Fannie Mae and Freddie Mac to these arenas.
In addition to reducing both the risk of consumer default and the volatility of the cost of consumer credit, Ohio HLTV lending also enables consumers to liquefy the value of their home equity in times of recession—in effect to maintain smooth consumption during fluctuations in income. Just as firms benefited from the greater financial flexibility afforded by expanded opportunities in bond markets in the late 1980s, consumers benefit from the ability to convert illiquid home equity (and good credit reputations) into quick cash.
Without HLTV lending during the recession of the early 1990s, many consumers experienced significant increases in their LTVs as economic devaluations reduced home values. Caplin, Freeman, and Tracey used data from the early 1990s recession to establish that when adverse economic shocks cause property values in a region to decrease, the damage to collateral makes it difficult or impossible for some homeowners to obtain new Ohio mortgages. . . . In regions suffering from adverse economic conditions, the ability to refinance will likely be constrained by declining property values.
As LTVs increase into the 80–90 percent region, the costs of refinancing increase due to the need for [private Ohio mortgage insurance]. As LTVs increase past 90 percent, homeowners may be completely rationed out of the refinance market. . . . This inability to refinance has further economic impacts on the region through lowering the wealth and the discretionary income of the local homeowners, thereby deepening the regional recession (1997, 496, 498–99) when consumers reduce spending because of liquidity
pressures or personal bankruptcy.
The authors’ findings therefore suggest that HLTV lending can help households weather the effects of recessions and can significantly stabilize shocks to aggregate demand that would otherwise have more severe effects on the economy.
For more information about Ohio home mortgages visit http://www.localmortgagecompanyohio.com
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