On the GSEs (again)

This is an excerpt from my commentary at the Berkeley-UCLA conference on the mortgage meltdown:

Fannie and Freddie’s management teams did unseemly things with respect to accounting, it is very hard to argue that they behaved worse with respect to risk management than investment banks or regulated commercial banks. According to the firms’ monthly volume summaries, their delinquency rates on single-family mortgages remain below 1.6 percent as of November 2008; according to the Mortgage Bankers Association, the overall delinquency rate for that time for the single-family market was 3.93 percent for prime loans, and more than 18 percent for subprime loans. Again, this does not necessarily reflect virtuous management, but rather the fact that the GSEs’ regulator, then the Office of Federal Housing Enterprise Oversight, while often accused of being a weak regulator, actually prevented the firms from engaging in the worst sorts of underwriting behavior. Also quite remarkable is the fact that the delinquency rate for Fannie and Freddie multi-family loans remains at around a basis point.
Among the consequences of this regulation is that the firms lost market share (Figure 1). The pink line in the graph is Fannie and Freddie’s share of mortgage debt outstanding. Note that while it declined sharply from 2002 to 2006, the private label market gained the market share that the GSEs lost. Under the circumstances, it is hard to make the case that the GSEs were the fundamental cause of the mortgage crisis, although many critics would like to think so.
I should disclose that I worked at Freddie Mac for around 15 months. One of the things about the place that was quite striking to me is how seriously its staff took mortgage underwriting. The credit models for the prime book (the business Freddie should have stuck to) were sophisticated, and the arguments about how to do underwriting were at once passionate and scientific. The people responsible for modeling credit risk were, by any standard, well qualified to do so. The chief risk officer of the company at the time discouraged senior management from expanding beyond the prime mortgage business. The GSEs arguably performed their job better than FHA, which has always had limited resources for developing underwriting models.
Senior management of the GSEs was under tremendous pressure to expand their business lines beyond prime mortgages because of the above documented loss of market share. This led both companies, and particularly Freddie Mac, to expand investment into Alt-A mortgages, and it was these mortgages that caused Freddie Mac so much trouble. Had OFHEO been a stronger regulator, or had Freddie Mac been statutorily prohibited from making Alt-A mortgages, the company would still be solvent.
This phenomenon had nothing to do with Freddie Mac’s portfolio per se; even if the GSEs had been in the guarantee business alone, they still would have been under pressure to increase their business. Securitizers in the pure private market put fee generation ahead of due diligence when determining whether to fund mortgages. Keys et al. (2008)showed that loans that were more easily securitized received less lender scrutiny than those that were more likely to be held in portfolio.
If we are going to have GSEs, their re-emergence should rest on four pillars. First, as Jaffee and Quigley suggested in an earlier paper, their cost of funds should reflect the risk they take. This could be accomplished through a tax on new debt issuance. Second, GSEs should be stringently regulated so their products do not depart from high standards of underwriting. Third, to assure one and two happen, GSEs should be forbidden from lobbying. Finally, minimum capital requirements need to be higher, although this (along with the tax on new debt) will raise mortgage costs.
This does not mean the end of GSEs as we know it, but rather a roll-back to where they were in the middles 1990s. Recent events make it clear that the economy cannot rely on the purely private sector to fund 30 year fixed rate mortgages.

The Surprise
If one looks at commentary from the earlier part of this decade on the GSEs, one finds that most of the concerns about them involved market (interest rate) risk, rather than credit risk. Because nominal house prices rose nationally every year between the end of World War II and last year, it was hard to imagine that mortgages would induce a credit crisis. Certainly no empirical model could have predicted the events of the past few years.
This has powerful implications for how we think about capital going forward. Among other things, it suggests that the model-based capital standards proposed in Basel II are not sustainable. It also suggests that there is no substitute for rigorous and admittedly somewhat arbitrary minimum capital ratios for all institutions that lend. This will inevitably mean that the economy will lose out on some positive net present value opportunities. But it also means we will be far less likely to find ourselves in the current situation

John Quigley's solution to the mortgage crisis

But for two things, I like it:

The foreclosure crisis is at the heart of the more general economic crisis. Protecting homeowners at risk of foreclosure is therefore an obvious priority. Here I outline a plan to ameliorate the foreclosure crisis, using the FHA’s mortgage authority to force lenders to recognize the actual values of homes and thus to restructure loans accordingly. The plan has four basic elements.

1) All those who purchased homes after a specified date are eligible, period. There is no distinction between those in arrears and those current in payment. There is neither time nor reason for a fight about moral hazard.

2) Participating homeowners will pay a small amount to register and receive an appraisal of current house value from the Federal Government.

3) If the household is able to make payments on a new first mortgage with a 40 year term for this appraised value, using standard underwriting criteria, then the household will be offered a new FHA mortgage. This new mortgage will be structured as interest-only for an initial period of years. This mortgage will be guaranteed, and premiums will be paid into the existing Mutual Insurance Fund administered by FHA.

The mortgage under these new terms will be reported to the master servicer, who will replace the existing contract with the new contract. Servicers will inform the owners of securities in any pool containing parts of the previous mortgage, and servicers will continue to pass on payments made by homeowners under the new contract to owners of existing mortgage pools or other securities.

4) In addition, when the new contracts mature or are terminated, any capital gain, net of costs, will be divided, with a small fraction accruing to the homeowner. The residual gain, net of costs, will be transmitted to the servicer who will distribute it to the owners of securities or pools in which the mortgage is bundled.

The Big Picture:

The most important thing is that the government force these revised mortgage contracts to be marked to market quickly, to reflect the actual value of the underlying housing.

There also doesn’t need to be a fight over securing the agreement of lenders or owners of securities. Some financial gurus claim that the sanctity of contracts requires agreement. This is nonsense. Terms of contracts are changed all the time by legislation. All this legislation does is to recognize the current market value of the contract. Finally, the biggest contractual change ever in American financial history, the abrogation of the gold standard, was made unilaterally by FDR. If this plan were adopted tomorrow, it would still take a lot of time to gear up a Home-Owners-Loan-Corporation (HOLC)-like appraisal process for hundreds of thousands of appraisals. And time is of the essence. So we need a simple program that can be implemented as soon as you are able to move.

And the cost? With 12M households currently holding underwater mortgages, we can safely assume that the average writedown would be less than $100,000. With a 1 percent default rate on new loans, and a loss on default of $100,000, this might add up to $12B. I used to think this was a lot of money. If the average write down were $100K, and housing prices did not increase at all before the new contracts were terminated or matured, the total private write down would be $1.2T.

This figure does not represent a new loss to the lenders, but rather is a recognition that the underlying asset is less valuable. Each lender or servicer will be given a coupon entitling him to some percentage (perhaps even 100%?) of the gain in value between the date of the new contract and the date of contract termination or maturation.

In effect, we force holders of this paper to mark these assets to market today, and preserve their right to any capital gain on the assets which have been marked to their current value. (But don’t let the bastards securitize these coupons.)

Details:

1) Eligibility is not based on delinquency in payments, and those who have struggled to make payments are not disadvantaged relative to those who are in arrears. The “right” –utterly arbitrary — date of eligibility might be January 1, 2004. (Subprime mortgages increased from about 9 percent of originations in January 2003 to 18 percent a year later, and to almost 22 percent in January 2005.)

2) Participation costs are meant to be small, a hundred or two hundred dollars. The appraisal will be some average of estimates of replacement cost, rental value, and current selling price. This is the same procedure used by the HOLC, and it will not underestimate the current value of the house.

3) The “standard underwriting criteria” could involve the 38 percent payment-to-income ratio of the New Hope Alliance, or Sheila Bair’s number. (I prefer Bair, but I also like vanilla.)

4) The interest-only aspect of the mortgage is not essential, but we are in a recession. That period could be limited to two years.

5) The new mortgage will be structured just like “regular” FHA mortgages with a payment by the household into the FHA’s mutual insurance pool.

6) The owners of the existing mortgages will share in any capital gains realized during the term of the new contract, perhaps in proportion to the writedown in asset value under the new contract. As a result, this is not a constitutional “taking,” and claims to the contrary are incorrect.

My two quibbles:

(1) John is a terrific, admirable economist (there is a difference between the two adjectives) and has long been an intellectual hero of mine. That said, he is not a lawyer, and so I am not sure we can be so sanguine about mass contract modification. Then again, I am not a lawyer either...

(2) I think cap gains should be split at something like 50-50 between homeowners and lenders. If nearly all the cap gains go to lenders, owners will have less incentive to maintain, to expend effort when selling, etc.

Blocks

Daniel Solomon, in his book, Global City Blues, makes a nice point about city blocks: of you want to have a vibrant street life, you need short blocks. San Francisco provides a nice natural experiment. Below is a Google Earth picture of San Francisco:



Notice that there are two grids: one is north of Market Street, and the other is south of Market (SOMA). The area north of Market is among the most inviting urban places I know for a walk; the area south of Market is more intimidating and, in some places, rather sketchy (although it must be said that the Tenderloin, which is north, is rather sketchy too--in the movie Milk, someone points out that among San Fracisco's leading problems is the smell of urine in the Tenderloin). In any event, there is no question that the street life in the northern grid is more vibrant.

What's the difference? It is fairly obvious that the grid north of Market is much tighter. For some reason, this makes it more humane.

I worry that this phenomenon will inhibit downtown Los Angeles from ever becoming a destination for pedestrians. The blocks are extremely long. Once a street grid is in place, it is hard to change it.

Are we calming?

The TED Spread is under 100 bp (just). And my colleague Raphael Bostic points out that intra-day stock price volatility has dropped precipitously. Perhaps soon-to-be- President Obama is soothing us?

One way to define bubble cities

I gave a paper (with Chris Redfearn and Stuart Gabriel) at ASSA last week on how interest rates and income get capitalized into house prices. Our preliminary results show that the following cities had house price elasticities with respect to income of less than one before 1997, but greater than one thereafter:

Albuquerque
Allentown
Amarillo
Appleton
Atlanta
Austin
Baltimore
Barnstable Town
Baton Rouge
Beaumont
Binghamton
Bismarck
Bloomington
Boise City
Boulder
Bridgeport
Canton
Cape Coral
Cedar Rapids
Charleston-SC
Charlotte
Chattanooga
Chicago
Cincinnati
Columbia
Columbus
Corpus Christi
Cumberland
Dallas
Davenport
Deltona
Denver
Des Moines
Detroit
Durham
Elmira
El Paso
Erie
Eugene
Fargo
Farmington
Gainesville
Glens Falls
Grand Rapids
Green Bay
Greensboro
Greenville
Gulfport
Hagerstown
Houston
Jackson
Jacksonville
Kansas City
Kennewick
Kingston
Knoxville
Lansing
Las Vegas
Lincoln
Little Rock
Louisville
Madison
Memphis
Miami
Milwaukee
Minneapolis
Mobile
Norwich
Ocala
Orlando
Palm Bay
Pensacola
Philadelphia
Phoenix
Pittsfield
Portland-OR
Raleigh
Reno
Richmond
Rockford
Salem
Salt Lake City
San Antonio
Sarasota
Shreveport
Sioux Falls
Spartanburg
Spokane
Springfield-MO
Syracuse
Tallahassee
Tampa
Toledo
Topeka
Tucson
Virginia Beach
Washington
Youngstown

This may be one way to define bubble cities. In cities such as Boston and Los Angeles (where the elasticity is always greater than one), large price swings might reflect the fact that the short run supply curve is strongly inelastic.

My friend Stuart Gabriel (UCLA) sends me a petition

And I signed it. I encourage other scholars to do so:

Scholars For Peace in the Middle East

*Promoting Academic Integrity and Honest Debate*

*Petition to Protest Canadian Union of Public Employees (CUPE) Proposed
Boycott of Israeli Academics*

/Written by: SPME Board of Directors/
*January 8, 2009* *To: Academic Colleagues From Around The World to
Protest Canadian Union of Public Employees (CUPE) Proposed Boycott of
Israeli Academics*

We, the undersigned university faculty members from around the world
call upon the members of the Canadian Union of Public Employees (CUPE)
to oppose any resolution to ban Israeli academics from teaching in
Ontario or anywhere else. The current resolution invokes, as
justification for the proposed ban, bombing that damaged the Islamic
University in Gaza on December 29. Sid Ryan of CUPE's Ontario University
Workers Coordinating Committee says: "Israeli academics should not be on
our campuses unless they explicitly condemn the university bombing and
the assault on Gaza in general." No other country's academics have been
the targets of such union action before, whether or not their country
was at war. Israel is engaged in a war to defend its people against an
enemy that has been firing missiles at Israeli civilians for years. The
enemy, Hamas, had been using the Islamic University as a training camp,
launching pad, and weapons depot. Oth! er universities in Gaza were not
Hamas facilities and were therefore not bombed.

The proposed ban clearly represents ethnic discrimination, and the
proposed ideological litmus test is a violation of free speech. The
members of the University and College Union in England recently rejected
a similar proposal because of its discriminatory nature, and we urge the
Ontario CUPE members to reject the proposal now before them.

To show our solidarity with our Israeli academics in this matter, we,
the undersigned, hereby declare ourselves to be Israeli academics for
purposes of any academic boycott. We will regard ourselves as Israeli
academics and decline to participate in any activity from which Israeli
academics are excluded.
*? *Visit Scholars For Peace in the Middle East website
*http://www.spme.net*

*? *To Sign this petition go to
*http://www.spme.net/cgi-bin/display_petitions.cgi?ID=15&Action=Sign
*

*? *To see current signatures go to
*http://www.spme.net/cgi-bin/display_petitions.cgi?ID=15&Action=View
*

Hope from Lutz Kilian?

He has the lead article in the new Journal of Economic Literature on the Economic Effects of Energy Price Shocks. He calculates a one year elasticity of consumer expenditures with respect to retail energy prices of
-.15. The energy component in CPI was down 13 percent from a year ago in November. If the coefficients on his model are stable, this implies consumption growth of 2 percent over the next year. Then again, one of the points of the paper is that the coefficients on such models are not particularly stable.

Syllabus for PPD 437

University of Southern California
School of Policy, Planning, and Development
PPD 437 Advanced Finance and Investment for Planning and Development
Course Syllabus – Spring 2009

Instructor name: Richard K. Green
Instructor phone: (213) 740-4093
Instructor email: richarkg@usc.edu

Course Objectives
This course is an introduction to the fundamental concepts and analytical methods used in making investment and financing decisions. During the course we will begin with single unit residential (single family homes or condominiums) finance and work our way to income producing property finance. By the end of the semester, you will be able to evaluate an income producing property and use pro forma analysis to estimate a value and forecast an investment return. This course will provide you with the basic financial analytic tools for understanding the determination of prices and values in the real estate investment, finance and development arena. Topics will include valuation techniques (especially discounted cash flow analysis) and the relationships among them, as well as issues relating to the uses of debt and equity, leases, taxes, and risk analysis.

At the core of the course is the notion of property valuation. We will begin with a very basic, stylized model and gradually add real-world complexity throughout the semester. We will consider investment in both “stabilized” (fully operational) income producing properties as well as development projects as time permits. We will build our models upon the modern corporate finance and investment curriculum, focusing in particular upon discounted cash flow methodology and the tradeoffs between risk and reward.

Reading Materials
The required text for this course is: Brueggeman and Fisher: Real Estate Finance and Investments, Thirteenth Edition. There will also be numerous reading assignments and financial models/templates available on the Blackboard system.

Required Course Materials
All students must have a calculator with financial functions: HIGHLY recommended model is the Hewlett Packard 12C, which will be used for all in-class examples. All other calculators will need to be learned independently. Students must bring calculators to all classes and exams. Students will be at an extreme disadvantaged if they do not have calculators for exams.

Students will need to have access to Excel in order to complete many of the assignments later in the class. Bringing a notebook computer is also recommended.

You must have access to the Wall Street Journal, LA Business Journal, and a business weekly, such as Businessweek. Students should keep abreast of local and national news and trends in the real estate market. The first 5-10 minutes of class will be spent discussing real estate issues in the news. Each of you will be responsible at some point for leading this discussion.

Course Requirements and Grading
The Course is divided into 16 weeks. Everything done in the class is quantified, including attendance, participation, homework, exams, presentations and final project. There are 502 total points that can be earned during the semester. Students will be graded on their performance on a take-home mid-term (75 points or 15.0%), in class mid-term (125 points or 25.0%) and final project (200 points or 40.0%); homework assignments (60 points or 12.0%) and in-class participation, including demonstrating an understanding of the week’s homework assignments and attendance (42 points or 8.0%).

Class meets once weekly, from 6 pm to 9:30 pm on Tuesday, beginning January 13, 2009 and continuing through April 28, 2008. The final project will be due on Tuesday, May 5, 2009.


Homework
Homework will consist of sets and case assignments, which are designed to give the student the opportunity to employ the techniques of valuation and market analysis in a practical context. These assignments will be graded on a full-credit/no credit basis. To receive full credit, the student should have made a reasonable attempt to solve every problem assigned. All homework assignments earn 10 points to each student.

Take-Home Exam
Students will be tested on class material via one take home exam. Students may work independently or in groups of no more than 3 to complete the exam. Students may choose their teammates.

The exam is worth a total of 75 points.

In-Class Exam
Students will be tested on class material via one mid-term. There will be no final exam. Example problems and study guides will be distributed near the date of the exam to familiarize the student to test formats and expectations.

The exam is closed book and is worth a total of 125 points.

Final Project
The culminating learning experience of this class will be a project requiring you to seek out an actual real estate investment opportunity in the Los Angeles area, evaluate that opportunity, and present your findings to the class. Students will be required to work in groups of 3 to 4 for this project, no exceptions. Further details on acceptable property types, deliverables, etc will be discussed later in the semester.

The final project is worth a total of 200 points and will be based upon the report, presentation and internal group evaluation.

Participation
Lectures will take place once a week and attendance is mandatory. You should arrive on time and should not leave until class is dismissed. Students are awarded 3 points for each class attendance. Only verified personal emergencies will be considered excused absences. If a student is absent more than 3 classes then student shall receive zero credit for attendance for the semester and may be subject to an incomplete for the semester. Total attendance represents 8.0% of your total grade.

Disability Services
Any student requesting academic accommodations based on a disability is required to register with Disability Services and Programs (DSP). A letter of verification for approved accommodations can be obtained from DSP. Please be sure that the letter is delivered to me as early in the semester as possible. DSP is located in STU 301; their phone number is 213-740-0776.

Academic Integrity
The use of unauthorized material, plagiarism, communicating with fellow students during an examination, attempting to benefit from the work of another student, allowing another student to benefit from one’s own work, and similar behavior that defeats the intent of an examination or other class work is unacceptable. Where a violation has occurred, the student will receive an F in the class and may be subject to disciplinary action at the University level. Examples of violations include (but are not limited to) copying off another student, allowing another student to copy off your paper, using a “cheat sheet” in any form during an exam, and refusing to stop when time is called.


Week 1: January 13, 2009
Lecture Topics:
• General Introductions
• Introduction to the course, syllabus and expectations
• Introduction to the Real Estate Industry. “Where to find a job?”
o Developers, Builders, Financing, Consultants, Government
• State of the Market lecture.
• Discussion on Legal Concepts (Chapter 1)

Reading assignments: B&F: Chapters 1 & 2

Homework assignment: None


Week 2: January 20, 2009
Lecture Topics:
• Market Topic (RG presents)
• Discussion of Notes & Mortgages (Chapter 2)
• Calculator Tutorial
• Discussion on Time Value of Money and Fixed Rate Mortgages (Chapter 3)
o Notes & Mortgages
o Present Value (PV)
o Future Value (FV)

Reading Assignments: B&F: Chapter 3 & 4


Week 3: January 27, 2009
Lecture Topics:
• Market Topic (Group 1)
• Recap Week 2
• Review PV, FV and Fixed Rate Mortgages (Chapter 4)
• Begin discussion on Adjustable Mortgages (Chapter 5)

Reading assignments: B&F: Chapter 5


Week 4: Feb 3, 2009
Lecture Topics:
• Market Topic (Group 2)
• Recap Week 3
• Adjustable Rate Mortgages (Chapter 5)
• Sample Problem work

Homework assignment #1: Problem Sets (handed out in class)


Week 5: Feb 10, 2009
Lecture Topics:
• Market Topic (Group 3)
• Review Homework Assignment
• Recap Week 4
• Residential Financial Analysis (Chapter 6)
o When to refinance, what loan term to select, what loan structure to choose?
o Current financing failures
• Singe Family Housing: Pricing, Investment and Tax Considerations (Chapter 7)

Reading assignments: B&F: Chapter 6 & 7


Week 6: Feb 17, 2009
Lecture Topics:
• Market Topic (Group 4)
• Residential Financial Analysis (Chapter 8)
o When to refinance, what loan term to select, what loan structure to choose?
o Current financing failures
• Singe Family Housing: Pricing, Investment and Tax Considerations
• Underwriting and Financing Residential Properties
• Key real estate terms/concepts

Reading assignments: B&F: Chapter 8

Take Home Mid-Term Handed Out and DUE WEEK 7

Week 7: Feb 24, 2009
Lecture Topics:
• Market Topic (Group 5)
• Mid Term Review
• Introduction to Income-Producing Properties: Lease Types, Rents, Expense Reimbursements and the Market for Space
• Creating the Static Pro forma (you will need to build a pro forma on the mid term and come to a value)

Reading assignments: B&F: Chapter 9


Week 8: March 3, 2009

Mid Term

Week 9: March 10, 2009
From this point we’ll be using Excel
• Quick Excel Tutorial (if you have notebooks bring them. We may be able to secure a computer lab)
• Offering Memorandum (OM)
o Property Description
o Location Analysis
o Market Analysis
• Three Methods of Value
o Cost Approach

Homework assignment #2: Individually find an income producing property on Loop Net (www.loopnet.com) that is currently for-sale and write-up a Property Description and Location Analysis for the property. Remember, you are pitching this property to potential investors or debt sources so make it sound good.


Week 10: March 24, 2009
Lecture Topics:
• The Three Methods of Valuation
o Cost Approach Review
o Sales Comparison Approach

Homework assignment #3: Find 5 sale comparables on Loop Net or equivalent (actual sales or listings) and use the template found on Blackboard. Adjust your property to the comparables using the adjustment chart found on Black board. Provide a narrative justifying the adjustments and conclude with a Sales Value for your project.


Week 11: March 31, 2009
Lecture Topics:
• Guest Lecturer – Los Angeles area Appraiser
• Income Approach to Value (continued)
o Direct Capitalization Approach to Value (static pro forma)
o Income & Expenses
o Capitalization Rates
• Creating a Discounted Cash Flow (continued)
o Internal Rate of Return (IRR)
o Discount Rate
o Residual Value (Exit Capitalization Rate)
o Net Present Value (NPV)

Homework assignment #4: Individually, pull 5 rent comparables (actual leases or listings) use the template found on Blackboard. Adjust your property to the comparables using the adjustment chart found on Black board. Provide a narrative justifying the adjustments and conclude with a Market Rent for your property.


Week 12: April 7, 2009
Lecture Topics:
• Guest Lecturer – Equity Broker
• Form Final Project Groups
• Analyzing the capital stack
o Sources of capital
o Debt vs. equity
• Calculating Leveraged Returns
• Modigliani-Miller

Homework assignment #5: In your group, go out and find an income producing property (this is the start of your Final Project). Property must be submitted with property and location descriptions along with photos and a brief paragraph explaining why the property was selected. Additional information will be provided in class. Assignment will be due the beginning of Week 15.


Week 13: April 14, 2009
Lecture Topics:
• Guest Lecturer – Los Angeles area Equity Investor (Chris Chee, Blackstone)
• Case Studies

Reading assignment: A case study will be handed out for review. We will discuss in detail following week.


Week 14: April 21, 2009
TBD

Week 15: April 28, 2009
Lecture Topics:
• Primer on the Development Process and financing
• Review and question answer session


Week 16: May 5, 2009
• Presentations (20 Minutes each)

Syllabus for FBE 589

University of Southern California
Marshall School of Business
Department of Finance and Business Economics

Professor Richard K. Green
Spring 2009
Mortgages, Mortgage-backed Securities and Real Estate Capital Markets
FBE 589 (15473)

Tuesdays and Thursdays


A. COURSE OVERVIEW

This course provides graduate-level exposure to theory and analytical methods used for valuing and pricing mortgages, mortgage-backed securities, and derivatives. In doing so, this course provides insight into not just how mortgage-backed securities and real estate capital markets operate, but also why. It provides a broad overview of mortgage-backed security, in-depth discussion of specific structure finance products, and hands-on exercises to enhance learning of key concepts.

The growth in the scale and complexity of the U. S. mortgage market since the securitization revolution of the 1980s has been enormous. The volume of outstanding mortgage related securities has grown to $7.4 trillion as of the first quarter of 2008. In comparison, the volume of outstanding marketable Treasury securities was about $5 trillion, total corporate debt securities was about $5.9 trillion. The Federal agency mortgage-backed securities outstanding has increased by more than ten times over the last two decades, from about $348 billion in 1987 to over $3.5 trillion by the end of 2007.

At the same time, the market also witnesses the unprecedented turmoil in the secondary mortgage market led by the meltdown of the subprime market starting in late 2006 and early 2007. As one of the most recent fatalities of the subprime fallout, on July 12, 2008, FDIC seized IndyMa
Bank, which had $32 billion in assets and over 10,000 employees, in what regulators called the
second-largest bank failure in U.S. history. FDIC's insurance fund has assets of about $52 billion. The House (on July 23, 2008), and the Senate (on July 26, 2008), overwhelmingly passed a landmark housing bill – the Housing and Economic Recovery Act of 2008 – that will offer up to $300 billion in loans to rescue some 400,000 homeowners at risk of foreclosure in the current crisis, as well as restoring investor confidence in the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Since then, Fannie and Freddie have been placed into receivership, and Congress has passed the Trouble Asset Relief Program (TARP). We live in interesting times.

The primary objective of this course is to combine the theory of finance with the practice of real estate capital markets to enable you to make intelligent business decisions in increasingly complex and turbulent real estate markets.

B. COURSE ORGANIZATION AND REQUIREMENTS

The course is a combination of lectures, guest presentations, and discussions. There are several
assignments which will not be graded, but suggested answer to the assignments will be posted on
tBlackboard. There is also a group project to be completed by two-student teams. A list of topics for the group projects will be distributed during the semester. Each team will pick a topic and work together to complete their project before April 21. Each team should prepare a 15-minute PowerPoint presentation of the highlights of the project in classes on April 23 and April 28. Each team will also read and prepare comments on one project prepared by another team. Each project group should deliver a draft report to their discussant team by April 21. The report may not exceed 15 pages (double-spaced). The final project report is due on December 3rd.

There will be three quizzes but no final exam. You must have a financial or programmable calculator that can compute annuities and present values. You are responsible for knowing how to use these functions. You will be very unhappy if you take the quizzes without one.

C. COURSE GRADING

Each Quiz: 20%
Project 30%
Class Participation 10%

D. TEXTBOOKS AND READINGS
Textbook:
Andrew Davidson, Anthony Sanders, Lan-Ling Wolff and Anne Ching, (2003) Securitization:
Structuring and Investment Analysis, Wiley Finance. ISBN: 978-0-471-02260-2.
Optional Reference Books:
Anjan V. Thakor and Arnoud W. A. Boot, (2008) Handbooks In Finance: Handbook of Financial
Intermediation and Banking, North-Holland. ISBN: 978-0-444-51558-2.
Danny Ben-Shahar, Charles Ka Yui Leung and Seow Eng Ong, (2008) Mortgage Markets
Worldwide, Blackwell Publishing. ISBN: 978-1-4051-3210-7.

E. BLACKBOARD COURSE INFO WEB SITE
Lecture notes, assignments, solutions, your grades and other communications will be posted on a
Blackboard Course Info web site at http://blackboard.usc.edu under “20091_FBE_589_15473: MORTGAGES AND MORTGAGE-BACKED SECURITIES AND MARKETS (20091_FBE_589_15473).”
Your login ID to the FBE 589 course web site is the first part of your USC email ID before
@usc.edu. Your password is your USC e-mail password. Please make sure you can access the
course web site and download the course materials there.

F. INSTRUCTOR ACCESS
I will hold office hours on Tuesdays 1:00pm - 3:00pm or by appointment. Appointments are
recommended even during office hours as meeting schedules may occasionally conflict with
office hours. E-mail is a dependable way to communicate with me. I will respond to all emails within 24 hours.

Professor Richard K. Green
Office: Lewis Hall (RGL) 331A
Tel: (213) 740-4093
E-mail: richarkg@usc.edu

G. ACADEMIC DISHONESTY
The Use of unauthorized material, communication with fellow students during an examination,
attempting to benefit from the work of another student, and similar behavior that defeats the
intent of an examination, or other class work is unacceptable to the University. It is often
difficult to distinguish between a culpable act and inadvertent behavior resulting from the nervous
tensions accompanying examinations. Where a clear violation has occurred, however, the
instructor may disqualify the student’s work as unacceptable and assign a failing mark on the
paper.

H. DISABILITY STATEMENT
Any student requesting academic accommodations based on a disability is required to register
with Disability Services and Programs (DSP) each semester. A letter of verification for approved
accommodations can be obtained from DSP. Please be sure the letter is delivered to me (or to
TA) as early in the semester as possible. DSP is located in STU 301 and is open early 8:30 a.m. -
5:00 p.m., Monday through Friday. The phone number for DSP is (213) 740-0776.
4
I. CLASS MEETINGS (Note: speaker dates might change)
Date Topics and References
1. January 13 and 15 Introduction: Course mechanics. Overview of Real Estate Capital Markets.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 1-4.

Green and Wachter (2007), The Housing Finance Revolution, Proceedgins of the 31st Annual Economic Conference of the Federal Reserve Bank of Kansas City

2. Jan 20 and 22 Credit Risks in the Mortgage and Mortgage-Backed Security Markets.
Guest Speaker: Anthony Sanders, Bob Herberger Arizona Heritage Chair in
Real Estate Finance, Professor of Finance, Arizona State University (date may be changed)

• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 15, Ch 17.

3. Jan 27 and 29 Mortgage Basics.

• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 5.

4. Feb 3 and 5 Fixed-Income Basics: Yield Curve and Term Structure of Interest Rates, Term Structure Models and Bond Pricing Models. Guest Lecture: Amy Crews Cutts, Deputy Chief Economist Freddie Mac
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 7, Ch 10.

5. Feb 10 Pricing of Mortgage Prepayment Options, Option-adjusted Spreads and Monte-
Carlo Simulation.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 12-13.

Feb 12 Quiz 1

6. Feb 17 and 19 Mortgage Pass-Through Securities.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 6, Ch 8.

7. Feb 24-26 Stripped Mortgage-Backed Securities, CMOs, and REMICs.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch. 9, Ch 11.

8. March 3 and March 5 How the Securities Markets Affect the Value of Real Estate, Transaction Volume and the Business Decisions by Investment and Financial Institutes.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 10, Ch 14.

9. March 10 Introduction to Commercial Mortgages

March 12 Quiz 2


10. March 24 and 26 Commercial Mortgages, Prepayment Protections and Defeasance.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 22.

11. March 31 and April 2 CMBS and CDO Markets.

• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 23.

12. April 7 and April 9 REITs Case Study, Public vs. Private REITs.
Guest Speaker: TBA
.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 24.

13. April 14 What went wrong?

April 16 Quiz 3.

April 21 and 23 Group Project Presentations.
6
H. USEFUL WEBSITE LINKS
Lusk Center for Real Estate (http://www.usc.edu/schools/sppd/lusk)
Glossary of Finance and Economic Terms
(http://www.freddiemac.com/finance/smm/a_f.htm#A)
REMIC & SMBS Securities Glossary
(http://www.fanniemae.com/markets/mbssecurities/product_info/remic/r_glossary.html)
Bloomberg Market Rates (http://www.bloomberg.com/markets/rates/index.html)
U.S. Census Bureau (http://www.census.gov/pub)
NAHB Economic and Housing Data (http://www.nahb.org/facts/default.htm)
Financial Services Facts (http://www.financialservicefacts.org/index.html)
Office of Federal Housing Enterprise Oversight (http://www.ofheo.gov)
FannieMae (http://www.fanniemae.com)
FreddieMac (http://www.freddiemac.com)
National Association of Real Estate Investment Trusts (http://www.nareit.org)
Mortgage Bankers Association of America (http://www.mbaa.org)
The Bond Market Association (http://www.bondmarkets.com)
National Mortgage News (http://www.nationalmortgagenews.com)
American Real Estate and Urban Economics Association (http://www.areuea.org)
Urban Land Institute (http://www.uli.org)
Journal of Real Estate Finance and Economics (http://www.jrefe.org)
Real Estate Economics (http://www.areuea.org/publications/ree/)

Thoughts from the Rose Parade

Yesterday was another gorgeous Jan 1 in Pasadena, and the parade was especially enjoyable. A couple of thoughts:

(1) The Ballou (Washington, DC) High School Marching Band was amazing. The kids in the band were remarkably accomplished. This surely has something to do with its band director, Darrell Watson.

Ballou High School has proficiency rates on its standardized math and reading scores of less than 10 percent. The students there show that they can excel--if they have a caring teaching showing them the way.

(2) The National Association of Realtors had a float in the parade. There were lots of snarky comments in the crowd about the theme of the "dream" of homeownership. While the other floats got lots of applause, the silence as the NAR float went by was eerie.