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Security bill format for Mortgage

this is frm part 2 book 2 credit risk measurement and management and two chapters on securitization the good news for you guys is that we've talked about many of the topics inside of these two chapters there will be some new topics that we'll have to focus on but this could be considered really just a summary of much of the focus in you know the last ten or twelve chapters that we've talked about you'll see what I mean when we go through these learning objectives look at some of the bolded phrases inside of these learning objectives describes securitization process collateral cash waterfall special-purpose vehicles credit enhancements subprime mortgage you know so we've talked about these topics before the focus of this chapter will be just a little bit different than what we've done in the past so we'll have to focus on those subtleties and nuances but then look a little more than halfway down delinquency ratio default ratio monthly payment rate we'll do a little bit of math and we'll make sure that we know all of those definitions I mean look at these action words define and explain analyze now there is define and calculate for that delinquency ratio and I have a couple of slides to show you the mathematics behind it but it's really just a matter of computing weighted averages so let's go ahead and get started with a basic definition of securitization and this definition at that block point at the top is taken right right out of the chapter it's a sale of assets which generate cash flows from the institution that owns them to another company that has been specifically set up for the purpose and the issuing of notes by the second company look at all the commas and that sentence in fact when I was in the eighth grade I had an English teacher who who taught us how to diagram sentences and that was one of my favorite things to do as an 8th grader but if she asked us to diagram this sentence I would have probably scratched my head and said there are too many commas in there is not even a sentence anyway let me give you a little bit more of a streamlined example so that this securitization maid set makes sense you probably know that I love talking about my family I have three sons let's suppose I have these three sons and one is interested in monster trucks one is interested in PlayStation video games and one is interested in art and all three of my boys excel in these areas so much so that they have their own YouTube channel and combined they generate let's say $10,000 a month in income one does two thousand one does 5,000 one does three thousand there's the ten thousand a month so that's one hundred twenty thousand dollars a year and so we've got this cash flow coming into the household and suppose that my wife and I would like to take a long vacation and so we want to securitize the assets that we have maybe these may be our sons are not the assets but clearly their ability to generate income is an asset so what I do is I can package those three YouTube channels and put it into a big wheelbarrow a big a big fund and I can sell it to an investor and suppose I promised to transfer those cash flows to the investor and I can sell it to that investor today and so what's that $120,000 a year let's see 10% if that's a perpetuity what does that do that gets me up to 1.2 million and let me do some discount factor of what 60% so let's suppose I can sell this for 10 years for 750,000 dollars so what happens I raise this capital 750,000 dollars my wife and I we can go on some fantastic vacation now using that 750,000 and all I have to do is all I have to maintain the original asset right so I need to tell my three sons look for the next ten years you guys need to continue monitoring and expanding your YouTube channel now the cool thing about this is that I may not promise my investors 10,000 a month I may only promise them $9,000 a month anyway so that's what securitization I'm taking an asset and I'm turning it into cash today and making those cash flows kind of skip over me as the parent and go right directly to the investor so look at this flow chart here so we have the asset owner that would be me or the bank right we have a special purpose vehicle now I didn't say anything about that in my example but that special purpose vehicle is exactly what the name suggests that we've talked about this many many times you know it's kind of its own separate entity so I put the assets you know my son's three YouTube channels or if we're a financial institution I put some mortgages in there and then I sell them over to the capital market investors yeah so notice what happens in the rust-coloured and the orange color so asset transfer from the originator to the special purpose vehicle so the special purpose vehicle now owns those assets which means that there are different rules of bankruptcy for the special purpose vehicle and the financial institution so look at the orange there the SPV issues these asset backed securities to the investors and they can be divided into different classes or different tranches and look at the purple there over on the right can be a senior tranche can be some junior tranches which a lot of times are called mezzanine tranches and then the final tranche which is the most risky tranches it's always called the equity tranche because look at what we're doing here you know we're taking these fixed income securities like like a mortgage right and we're turning it into something that it kind of looks like a mortgage but because of the cash flows can be divided between an among different kinds of classes with different levels of risk you know that highest risk one looks an awful lot like a share of stock and that's why it's called equity one of those learning outcomes ask us for the benefits of securitization from both here let me do go back here from both the financial institution all the way over on the left and then the capital market investors over all the way over on the right and these are probably pretty important to remember from the bank's perspective diversify the funding miss mix right what does a bank to accept its deposits so it can it can accept you know checking accounts and savings accounts and certificates of deposits and short-term notes and long-term notes and bonds and equity right but what this does is it brings in a different class of investors who are searching for specific types of exposure so diversify funding milk mix that's probably important and also reduce the cost of funding I mean let's face it if I if I want to issue a 30-year bond to finance the issuance of a bunch of mortgages right I'm gonna have to pay Suman we have an upward-sloping yield curve I have to pay a high coupon rate or a high yield to maturity and then that eats into the profitability on the left-hand side of my balance sheet so if I sell it to investors who wants specific exposure except instead of just a regular old bond holder who wants bank exposure now I have an investor who wants specific exposure to a monster-truck YouTube channel that investor is probably willing to pay more for it which means the cost of funding goes down and that second one the second circle point there is probably important as well because remember as a financial institution we're subject to all sorts of laws and regulations and so these regulators they look at our balance sheet and they look down at the bottom right and they see what is your equity what is your capital and by using these special-purpose vehicles we can transfer some of our assets away remember this is off-balance sheet financing so that we can make our balance sheet look stronger a reduced credit risk exposure of course this is all part of the identify risk quantify risk and manage risk so we've done the first part identify we've done the second part we've quantified now we're managing it and so what we're doing is we're just saying you know what I'd like someone else to take this risk or transferring we're reducing our credit risk exposure now from the investor standpoint back in the academic world we call we call the spanning right so in the old sense of the word investors could either pick money market securities fixed income securities or equity securities knew they had three choices but spanning means that there are different chops in between all of those so look at that first circle point assets that would otherwise not be open to them like a credit card receivable this gives them unique investment opportunities and attractive risk return profiles because they're buying only those exposures from the bank that they want that they demand and as I said before they're willing to pay a higher price for that so that they yield and the cost of funding is less now one thing I want you to be careful of and maybe this is not just for exam purposes but you know just kind of general awareness purposes is that lots of times the benefits of diversification are always mentioned in this kind of a description and I just want to caution you that there are same some things that are like over diversification which really don't pay off or maybe kind of useless diversification diversifying just for the sake of diversifying so you can get in trouble there with diversification but as long as it as long as it maintains the original Harry Markowitz risk expected return trade-off then diversification is fine but just be careful about over diversification here's kind of a different flow chart and diagram on the securitization process from what we had before notice up in the dotted box we have the financial institution and then the assets that get thrown into the special purpose vehicle but what we need is we need someone to pay attention to the special purpose vehicle right we can't just as the financial institution put it over there and then not ever have to worry about we have to service it we have to have trustees we need to worry about credit enhancements and then ultimately we need to worry about those investors down on the bottom right and so we can issue you know a and B and C and any any kinds of any kinds of letters that we want and go for me all the way to Z if we really wanted them to although Z sounds probably like too many and so if you look at this slide here's kind of a summary of what one alone that previous slide being able to identify the party so there's the originator that's the that's probably the financial institution they put up they create this special purpose vehicle it could be a trust it could be a corporation I'll talk about that here in just a minute of course on the left-hand side of the balance sheet for financial institutions these are all the loan customers and what do they do when they borrow money for a house or a car or credit card they sign something that says I promise to repay right and then there's a servicer think about this someone has to collect all of those interest in principle payments and then make them available to the investors all the way on the right hand side here let me go back here right down at the bottom right make that interest in principle payment available to those investors that's called the servicer and it's probably going to be the original financial institution and then of course let me go back here real quickly look at the Oval on the right there the rust one credit enhancements then get thrown into the special purpose vehicle credit enhancements are those things that lower the default risk or the counterparty risk of that special purpose vehicle you know those in lewd things like asking an insurance company to guarantee payment or using collateral those of you listen to me before well no I love using that Pink Panther diamond as collateral and then there's the underwriter who you know you need really smart people to try to figure out let me go back here real quickly you need smart people to figure out you know what are the best number of a and B and C how can we divide these tranches to attract those specific investors who are going to be willing to pay a premium for our services and then the ratings agencies come in and they look at all this stuff and they say okay let me look at this pool of mortgages up at the top and if these pool of mortgages consists of people like like Jim let's just take Jim you know Jim is 58 years old now and he's been an associate professor of finance for a thousand years he's paid off every debt that he's ever had in his entire life his mortgage payment is this compared to his asset base and income of this but suppose there are a hundred people like Jim in this mortgage pool well then then Moody's R Fitch are gonna come in and say you know what that's probably triple-a rated three different structures that your chapter tells you about in terms of special purpose vehicles and the difference between the inflows and then the outflows and so for mortgage-backed securities it makes perfect sense to have some type of amortize instructor because as you guys know being good homeowners you pay fixed monthly payment part of that is interest part of that is principal and that changes over the life of the mortgage of course early on you pay huge chunks of interest and then later on you pay huge chunks of principal and so these amortization structures which are just really passed through so right what's happening is that the special purpose vehicle will receives my interest in my cube my principle payment and then takes that and then sends it off to the investors a revolving structure is probably not appropriate for mortgages but might be more appropriate for maybe a car loan and a credit card receivable because here let me go back here just quickly you know when you when you take out a mortgage loan let's say 30 years you know you're very sensitive to the interest rate you know a change in just a half percent of an interest rate can dramatically affect the total interest payment over 30 years but you know this is why auto manufacturers encourage their dealers to offer you know one percent financing or zero percent financing because over a four or five year period of course you're gonna pay interest but you're not gonna pay the amount of interest that you do in a mortgage right so so those are those are less important the amortizations structure is less applicable to auto loans and credit card receivables because you know look at someone like me I try to I try to pay my credit card balances off every month and although when we buy cars I don't pay off the auto loan early but what we have done is the fortunate we've had an accident that the car was totaled and nobody was hurt but then you know that loan then gets repaid you know somehow earlier so what the revolving structure does and this is pretty interesting you know think about someone like me who pays off the credit cards every month so let's just suppose my monthly bill as $1,000 and you bought you bought this asset-backed security based on my credit card receivable so you're looking at a thousand dollars everything okay thousand dollars all right I'm gonna let lots of interest on this but I pay it off every month and so what do you want do you want to be paid that $1,000 immediately or do you want it to lent out to somebody else who may not pay that credit card balance every month of course so that's what the revolving structure means look at the top purchase of new assets that just means finding someone to replace Jim who's not gonna pay the balance every month and then a master trust is a really interesting case in which the originator takes a huge amount of receivables you know let's suppose it's let's suppose it's a hundred million dollars right and puts them into a special purpose vehicle and once that special purpose vehicle is created and we attract investors we don't sell and try to raise a hunch what did I say 100 million maybe we only sell 80 million or 90 million all right so notice what that first block point a huge chunk of receivables that's much larger than the size of the funding so if you look at the you know the little picture down at the bottom right there this master trust we have issue 1 & 2 & 3 & 4 & 5 and then some residual assets here and this is one way one way to manage risk quick slide here on the difference between trust and a corporation notice important they're us they can only be set up as trusts which means that the special purpose vehicle then means that the investors the bondholders are represented by trustees but with the corporate form and this only happens in Europe they're controlled by the board of directors who can actually sign contracts so just remember differences between US and Europe laws now we've done a cache waterfall before let's go ahead and do this you know kind of quickly and this is really an interesting slide as well but it's a good summary of some of the things that we've talked about in the past let's suppose that we have some mortgage-backed security and so what's happening so all these people are paying their interest and their principal every month so this flows into one big old pool I always think of it as a wheelbarrow and so what happens there are fees associated with this special purpose vehicle right so we pay the trustee and we pay the administrative fees we pay the legal fees right and then if there's anything left over which oh my gosh I sure hope there is especially if this is the first monthly payment then we pay interest to the senior investors now let's suppose that the interest that we received is 10 right and so what could happen we may owe the class a senior's maybe we owe them 6 so we pay them 6 and then we have something left over so that takes us over to the left to the green but let's suppose that we collect 10 and we owe them 15 so now what now oh my gosh now we fail so what happens then if we fail then we revert over to the terms of the SPV and we start distributing the principal do we have enough principal to satisfy the a so the notice that the a gets some interest and in principle maybe it'll get some principal and so we waterfall we cascade all the way down so as soon as we fail on the interest then we start paying principal and that's true whether we go to the left or to the right so let's get back over to the past so we've paid the we've paid the interest to the a investors now if we have enough to pay the B then we keep passing and we go look at the bottom left there we pay interest on the C and then we pay interest on the D and the E and the F until we get down to that equity tranche right and then we start paying the principal starting with the a and the B and so on so there's the cash waterfall that's a cascading approach we have done that before credit enhancements we've all also done this before notice the very top improve the credit profile of the SPV to make the securitized assets more marketable what does that mean more marketable we want them to be willing to pay more for it so over collateralization how about my Pink Panther diamond example we can get some insurance company to insure us we can divide this up into different slices or tranches and remember we're not going to be sitting in our office and saying oh I met the tranche structured in this manner would really suit these people over there now what we do is we go to the other business units inside of the financial institution and say hey you're in contact every day with our investors what do they want and so you designed the traj so that you can market it to those people who have some kind of a pent up demand and then of course margins and excess spreads we've talked about that before now remember back in my original slide with the learning objectives I said there are a couple of definitions that we probably haven't discussed too much here here are some of them delinquency ratios default ratios and monthly payment rates let's look at a quick example here so that you can see how to calculate these and then how to interpret all right so we've got an asset-backed security that is supported by credit cards all right so we have outstanding credit card receivables of 60 million current receivables are 50 million which means that we expect to get 50 million of that 60 million back in the relatively short time period and then there are the past due so over 30 days our six and a half million over 60 days or another two and a half million and then over 90 days is 1 million and although some financial institutions might think over 30 days might be their definition of delinquency most banks tend to think of this in over 90 days so three months I guess financial institutions figure that if you don't pay in three months you're probably not going to pay but over 30 days I mean anybody can you know cash flows go like this right four households so almost anybody can can be delinquent over 30 days and it's just a matter of maybe just forgetting I got a bill from my municipality saying dear Jim why didn't you pay your quarterly sewage and garbage bill last quarter and I said to my wife I didn't even remember to pay it I something I forgot it's the first time in my life I never paid a bill on time so I had to pay a little fee and double it you know so 30 days 60 days all right you know whenever I see someone have 30 days she's always wondering why not 29 days there why not 31 days all right look at the bottom of the table there so we received one and a half million during May and then we're gonna write off 500,000 so let's go ahead and compute these ratios so that we can address those learning objectives so delinquency ratio there's the receivables over 30 days in the numerator so a million over the total of 60 gives us 1 point 6 7% delinquency ratio and then the default ratio is going to be the actual amount of credit card receivables that have been written off during the month of May so there's the 500 divided by the same 60 million so that's less than 1% and then the MPR the monthly payment rate is going to be our one and a half million over the 60 million so notice that we divide by 60 million in each of those so that gives us two and a half percent so looking at the mathematics there and then let me just go back to that previous slide you know that delinquency ratio there's a description of the 90 days there's the default ratio credit card receivables written off during that period and then the MPR is the percent of monthly principal and interest payments right divided by the total amount so there are the definitions there is the math so you ought to be able to you want to be able to do that pretty quickly on an exam now for a mortgage-backed security and let me just go back here quickly a mortgage-backed security we're we're less interested in doing things like computing a delinquency ratio or default ratio or a monthly payment rate although these these are important of course I don't want to ignore these for a mortgage-backed security but what's even more important is this debt service coverage ratio which as you can see is just net operating income over the total debt service and so look at the numerator these are cash flows left after paying all of operating expenses you know this is kind of like what I teach my capital budgeting students about operating cash flow the cash remaining after all expenses have been paid and then you divide that by the total debt service which are those costs related to servicing the debt and so this means interest and principal and any other obligations and so the important interpretation is one of these ratios to be equal to one right if it's less than 1 then the mortgages are not generating sufficient cash flows to cover those debt payments and so really this is just a ratio of you know what do you got versus what do you owe here a couple of other definitions and some calculations that we'll have to do before we get to the top let's look at the table down in the bottle note bottom notice we have five different bundles of mortgages with different principal amounts 10 million all the way up to 22 million and there are different coupon rates associated with each of those bundles because remember what do mortgage rates do they they change every day I mean maybe not quite every day but clearly they can change every day and so the question then becomes if we're putting these into a security and we have different amounts and we have different coupon rates right we have different interest rates associated with each of those mortgage bundles then what we're interested in is what is the coupon rate as it applies to the entire wheelbarrow add to the entire pool and that's where we get into this concept of a weighted average coupon so look at the bolded phrase at the top the average gross interest rate of the underlying mortgages in a mortgage-backed security and so look down at the bottom right what does that read they're six point nine six two five that is a weighted average coupon rate so if you look in the green all we're doing is waiting each of those coupons seven and a half eight six seven and six and a half by the fraction of the principle balance over the total so if you sum those you get eighty and so there you go using just some regular old math to calculate a weighted average clearly on an exam if you add this five coupons and divide by five that'll be a potential answer and that's probably not the correct answer you know I wish I could give you a shortcut in order to compute a weighted average although let me get my calculator out here if you look on I can't see cuz I got I don't have my bifocals I look under the number six you can see an X bar W that will help you compute a weighted average it does kind of shorten your investment in computing a weighted average but not by much now notice the difference between this table in the previous table we have the same bundles we have the same principle amounts but now instead of back here coupon rates here we've gotten days until the bundle matures and so what we're interested in is a weighted average maturity so over in the green we do the same kind of math and we get 259 so this is called a weighted average maturity and this is the average number of months until the final payment and of course they hire the weighted average maturity the longer it will take for all of the holdings in the portfolio to mature and then we'll go ahead and calculate a weighted average life which is going to be based on what your chapter calls a pool factor and look at the equation their outstanding principal balance over the original principal bounce so if the original principal balances is a hundred right and what do you do you after the first year or so you you know maybe you owe ninety two and then you owe and then you owe eighty seven and then you owe and then you owe so that pool factor you know it's not identical to the discount rate when computing present value but it's similar and so this weighted average life is a function of that pool factor summed by what we'll call you know some other kind of a principal dollar and divided by that 365 here let me show you what I mean in a table so down the left hand column we have payment dates from 2013 out to 2018 right and so there are the number of days so that first one we don't have three months we just have 66 days but then but then we have three months some are ninety rights number ninety one summer ninety two and there's that pool factor so it starts with one right present value is one and then we just kind of discount at ninety four ninety eighty nine all the way down to an 18 and the way we compute that is look at those outstanding balances so we start with about 90,000 or I'm sorry 90 million and during those during those that time period of sixty six days we've repaid a principal of about five million so if you do the 84 divided by the 89 you'll get you'll get the 94 and then you do the rest of the math over there and those final two columns and you get the weighted average life which is two point five seven four seven so let's go back here it's the average number of years that each principal dollar will be out now with mortgages of course there are going to be refinancing and there's going to be pre payments and so we need to worry about what happens with this prepayment risk because if we're a mortgage back investor we need to worry about receiving our principal too fast I mean let's think about it when do individuals refinance their mortgages they refinance when interest rates fall so we are receiving a higher interest payment based on that original high interest rate and so we like that when interest rates fall but then then and homeowners are going to refinance so they're gonna send us back the principal amount it's not like we can't accept it right that's what they owe us legal and binding contract and so now we have to reinvest that at the lower rate so pre payments are a huge deal in the mortgage-backed security market so look at that circle the first circle point there they can adversely affect the amount and timing of cash flows all right so how do we how do we estimate how do we determine how do we manage these pre payments two ways so a conditional prepayment rate and the PSA the public securities Association benchmark all right let me show you what I mean here the conditional prepayment rate is a proportion of the loans principal that is assumed all right right so that's the important one I assume to be paid off ahead of time at each period whether it's a refinancing or whether it's a sale of the house remember people people have mortgages and they move right this is always a percentage and it's always compounded annually so look at the bottom equation there there's the CPR which is an annual rate and so we need to convert that into a single monthly mortality rate ing to that formula there raise it to the 1/12 right kind of D compounding so to speak to go from an annual rate down to down to a monthly rate look at the second circle point there it's estimated based on historical prepayment rates for past loans with similar characteristics and future economic prospects alright so you can obviously see the problems with using the CPR because it's based on history and it's based on not only default rates and prepayment rates and economic conditions repeating itself into the future but we also have to look at the simple fact that of course there are dynamics within the economy that are going to change both of those things all right so we're gonna be using the the risk here is to using this single monthly mortality rate in conditions that were not present when that rate was computed and for those individuals inside of those mortgages they might have different personal financial scenarios that will change over time now that's why the PSA benchmark is popular because what it does is it assumes that this monthly repayment rate is not constant like the previous one but that it gradually increases as the mortgage pool ages and this makes a little bit more sense so look at the the second block point so if we have a CPR a point two percent for the first month and we're going to assume that increases over time and so we're gonna hit some maximum let's say at 6% after 30 months or or 48 months or whatever it is here's just a quick illustration of the relationship between time right there's months on the horizontal axis and that CPR in the vertical axis what we're worried about is heating benchmark so look in the middle that red or rust-colored 100 PSA that means that the prepayment experience is perfectly in line with the assumptions of the PSA model and then of course the green line is above and the purple line is below how about that learning objective on the subprime mortgage credit securitization process and we've talked about this many many times right somebody comes in and applies for a mortgage you do some credit checks boy we spent some good time on credit scoring back in a previous chapter so we make the loan and so what we're gonna do is we're gonna divide this loan in two I mean what we ought to do is divide this loan in two I don't know ten different parts you know high risk to low risk but financial institutions tend to do this in two categories prime loans in which those borrowers get the best rate and subprime loans in which the interest rate it depends and is a function of the extra risk associated with the borrowers lack of tremendous financial stability now of course these prime loans can be sold to lots and lots of people but Freddie Mac and Fannie Mae and these government-sponsored enterprises they buy most of these things the subprime loans which don't meet those high credit quality requirements can be sold to anybody else who wants them now of course there are going to be problems right let's go back here you know the prime loans are sold to the federal government let's say so the federal government gobbles up all of those low risk loans and then it's left to the rest of us to purchase these subprime loans so as subprime MBS investors we need to make sure that we're aware right the important thing is to first identify the risk and the only way that we can identify those risk is actually going to the financial institution and look at all the mortgages that make up that pool of course we can't really do that so we need to pay someone to do that for us so as you can imagine there are going to be conflicts and frictions and problems and so let's go ahead and look through a couple of slides about potential frictions here between two different groups of people that were listed on that previous slide all right how about being more with the mortgage or and the originator or typical subprime borrower is not financially sophisticated and may lack financial skills to analyze the borrowing alternatives tabled by the lender right so this has really been the big criticism of you know the greedy Wall Street bankers providing loans to individuals who really don't know what they're getting into you know when I have gone to the bank to borrow money for a house you know I have a fairly good background in figuring out you know here's my income and I can't afford to buy this big of a house that requires that kind of a mortgage payment but lots of people don't have my background or your background and they can be taken advantage of how about the originator and the issuer now let's think about this you know as a financial institution what's our job accept deposits and make loans so we need to make loans to those individuals and those businesses who are very likely to repay but if we are if we are in a scenario on which we know we're going to take those mortgages and put them into a pool and sell them well then we may not we may not be as honest as we would otherwise be notice the bottom sentence the originator may paint an overly positive financial condition of the borrower how about the issuer and third parties ratings agencies underwriters you know other financial institutions insurance companies so look the issuer may keep higher credit quality notes to themselves while securitizing the lower quality notes boy do we want to call them lemons how about the servicer and the mortgage or you know the the servicer servicers are charged with making you know key decisions on delinquent loans right we talked about this before 30 days or 60 days or 90 days you know for delinquent loans the mortgage or may have no longer have any incentive to maintain the property right or keep those home insurance payments up to date so if we're not ensuring a delinquent property and it and it falls to the ground for some reason well then that risk which we thought was transferred someone else might might be the risk of the of the servicer how about the asset manager and the investor all right so the complexity of the securitization process so lots of times we hire an asset manager so that we can find the best mortgage-backed security or asset-backed security however the investor may be unable to assess the managers effort objectively and informatively and how about the investor and ratings agencies right so this is one of the things that I have lamented about for many many years when actually when I first when I first discovered this probably when I was in graduate school it's not bondholders or the investors that pay the ratings agencies it's the issuer that pays the ratings agencies and so there are all sorts of tremendous conflicts that are when when you have this arrangement and how about that very final learning objective difference between predatory lending and predatory borrowing you know I want to make a comment here that applies to this slide but it also applies to all these previous slides here notice a theme about these kind of conflicts and frictions and that applies to this slide as well look if you and I are agreeing to trade right and I've done this many times in the past so we sign a forward contract to trade my trusted 12c financial calculator and you agree to pay me $50 for this thing in 30 days right so there's our traditional derivative security well what might happen in those 30 days I may drop it I may I may break it somehow I may take a sledgehammer to it but you don't know that and so all these problems are really come back to what I learned back in graduate school called asymmetry of information right and so one person in the transaction knows more about the value of the underlying asset than the other and that can pretty much explain all of these issues that we just talked about and so here the same thing with predatory lending so look unfair or abusive loan terms on the borrower deceptive actions they get into a house that they cannot afford or that they don't need predatory lending how about predatory borrowing look I could say to you if I if you're the financial institution and I come to you and say oh yeah I I have a million dollars and I may misrepresent on my mortgage application and I love telling this story quickly and I'll do it as quickly as I can because we're wrapping this up when I refinance the current home that we're living in I did this over the phone I did not have to provide any documentation I didn't have to provide a w-2 I didn't have to I'd any kind of my income tax return I didn't have to provide I didn't have to provide anything this was at the height this was 2004 2005 this was at the height of these know doc loans where I could have lied I could have just said yeah I have a million dollars my father is a wealthy wealthy dude and he's gonna lend me all he's gonna leave all this money to him to me when he dies alright so unfair terms misrepresentative and oh boy motivated by expectation that houses housing prices will keep going up we know that doesn't happen and that takes us through these kind of to summary chapters so not much new in these two chapters and I hope you can agree that combining them was probably a good thing so we did a little bit of a review of some topics that we've covered in the past and then the new pop topics like the define and calculate those ratios those were pretty straightforward so you ought to be able to do those on an exam [Music]