Appendix B

Housing Price Appreciation and Mortgage Credit Performance

The Importance of Housing Price Appreciation

The strong credit performance of private-label pass-throughs has benefited importantly from the appreciation of housing prices over the past four decades. Empirically, during periods of significant housing price appreciation mortgages tended to have a low incidence of default. And, even in the event of default, loss severity also tended to be modest, thanks to the rise in housing prices. The strength of all credit classes is derived from the size and the constant availability of their credit supports. Both the size and the availability hinge on the default frequency and loss severity of the underlying mortgages in the pool. With low default frequency and modest loss severity, the credit support will always be there to sustain or improve (upgrade) the credit of even the most junior classes. Conversely, with high default frequency and substantial loss severity, the credit support will be eroded to endanger even the most senior credit classes.

Over the past four decades, with the exception of 1991–93 and 2007–09, housing prices have appreciated smartly. This appreciation has greatly limited mortgage defaults and sustained credit performance of private-label pass-throughs since inception until 2007. The substantial housing price declines during 2007–09 have dwindled the market value of many houses to below the principal balance of the mortgages they secured. Confronted ...

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