The Economic and Financial Crisis: Genesis and Exit Strategies

Filippo Cobelli - 68875 – Università degli Studi di Brescia – Economia Internazionale 
	
  
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interest rate and high monthly payment, one that like violating the usual rule on the 
proportion of household income needed to service the debt. The bank system go 
around that problem introducing the ARM (Adjustable Rate Mortgage)
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, which had 
low initial payments that would last for the first two, three years, before reset to an 
higher monthly value. Borrower were told that in two or three years the price of their 
house would increase enough to allow them to re-finance the loan also because the 
home price usually rise by a 10 to 20 percent a year in many locations so as long that 
continued a loan to value ratio of 100 percent would decline to a 80 percent or so 
after a short time, and the household could re-finance with a mortgage with more 
favorable terms. 
 
 The boom in mortgage borrowing was originated by low interest rates and 
easier landing practices. The increasing in laxity of the leading standards are 
characteristic of classic behavior during bubbles. More important for housing prices 
as mortgage debt became more easily available, new buyers of housing entered the 
market; the “subprime”
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 borrower. The influx of these new borrowers who would 
traditionally not have had access to loans increase the house prices. The consumers 
came to expect housing prices to continue to appreciate at a high rate. This 
encouraged the entrance of new real estate speculators into the market. These new 
buyers again drove up housing demand and continued to propel the upsurge in 
housing prices. This final speculative demand in conjunction with the other force 
formed a housing price bubble. 
 
 
	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
   	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
  	
   	
  
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 An adjustable rate mortgage (ARM) is a mortgage loan where the interest rate on the note 
is periodically adjusted based on a variety of indices. Among the most common indices are 
the rates on 1-year constant-maturity Treasury (CMT) securities, the Cost of Funds Index 
(COFI), and the London Interbank Offered Rate (LIBOR). 
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 Loans that are in the riskiest category of consumer loans. The standards for determining 
risk categories refer to the size of the loan, structure of the loan, borrower credit rating, ratio 
of borrower debt to income or assets, ratio of loan to value or documentation provided on 
those loans which do not meet Fannie Mae or Freddie Mac underwriting guidelines for prime 
mortgages. Usually loans are classified subprime if the FICO score ( a composite score to 
measure the risk of default, it consist in 35% of payment history, 30% credit utilization, 15% 
length of credit history, 10% type of credit used and 10% recent search of credit and come 
times the special factors) of the borrower in below 640.